Economic conditions, including falling cash rates at home and abroad, are prompting investors to shake up their asset allocation. This is having an impact on allocations to direct real estate worldwide.
The state of play
At its October board meeting, the Reserve Bank lowered the official cash rate by 25 basis points to 0.75 per cent.
The RBA is not alone in its fight to kick-start the national economy. Developed nations worldwide are grappling with sluggish growth and below-target inflation figures, and there’s no end in sight for the mid-term.1
Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation
said RBA governor Philip Lowe in his statement supporting the cash rate decision.
One well-understood impact of this lower-for-longer environment is compression of returns from traditional safe haven assets like bonds and cash. As a result, institutional and retail investors alike are on the hunt for new opportunities, and we see that manifesting in a jump in investors’ interest in direct commercial real estate.
Key market observations
In the last 12 months, commercial real estate (CRE) has delivered an average return of 4.9 per cent, placing it amongst the highest income return of all asset classes.2
Further, investors worldwide have lifted their exposure to CRE, from an average of 8 per cent in 2012 to 11 per cent today.3 At AMP Capital, we anticipate this figure will continue to rise, reaching approximately 15 per cent by 2025.
However, it’s important to note that while falling cash rates will likely prolong the real estate capital growth cycle, which is currently in its ninth year of positive capital growth, we expect yields to compress in the office and logistics space over the next 12 months, as the cost of capital falls.4
Similar patterns and projections were identified in a report from Cornell University in the United States and capital advisory firm Hodes Weill.5
Its 2018 Allocations Monitor, which includes research collected from 208 institutional investors in 29 countries, said that, on average, institutions are expected to increase target allocations to real estate by 20 basis points over the next 12 months.
Further, the research found that after two years of “moderating” portfolio investment returns, performance increased in 2017. Real estate portfolios generated an average annual investment return of 9.2 per cent in 2017, up from 8.7 per cent in 2016, according to the report.
“This is consistent with industry-wide real estate returns, which trended upward in 2017, spurred by a rebound in economic growth which led to stronger operating fundamentals (i.e. rent and occupancy trends) across asset classes and geographies,” the report said.
Notably, the report also measured institutions’ view of real estate as an investment opportunity from a risk-return standpoint, using a so-called ‘Conviction Index’. After four years of steady declines, this index moved from 4.9 to 5.1.
Interestingly, on the flipside, despite 92 per cent of institutions reporting that they are actively investing in real estate, institutions remain approximately 90 basis points under-invested relative to target allocations, the report found.
One to watch
At AMP Capital, we anticipate the cash rate will continue to fall, potentially as low as 0.25 per cent by early 2020. As a result, we expect the hunt for yields and growth to intensify, as investors search for steady and prolonged sources of income. In this context, real estate will be one to watch as time wears on.
1 Source: https://www.rba.gov.au/media-releases/2019/mr-19-27.html
2 Source: IPD/MSCI Total Return Digest, Q2, 2019
3 Source: Cornell/Hodes Weill & PwC
4 Source: AMP Capital Real Estate Research as at September 2019
5 Source: https://www.hodesweill.com/research
Subscribe to Market Watch to receive my latest articlesLuke Dixon, Head of Real Estate Research
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