Where are we in the property cycle?
In the short term, the dominant concern for investors remains uncertainty over the length of the current global cycle. The sell-off in global equity markets in early 2016 was a potent reminder that asset markets are subject to large, periodic swings in performance, often closely tied to the underlying economic cycle.
Markets have been prone to frequent bouts of pessimism in recent years, reflecting the underwhelming pace of the global recovery and the fact that there is still an uncomfortably large list of potential downside risks that could trigger a renewed downturn, most notably: a sharp slowdown in China; higher interest rates in the USA triggering a deepening financial crisis in emerging markets; rising tensions in the Middle East; the looming UK vote on EU membership; and the presidential race in the USA.
Despite the gloomy sentiment, most economic forecasts still suggest that 2016 will be another mediocre year for growth – with the annual rate of growth in world output averaging around 3%. Lower oil prices, which largely reflect increased global supply rather than weak demand, will provide a continued stimulus to growth – reducing the cost of living, boosting household incomes and stoking consumer spending. Interest rates are also expected to remain low to support the recovery. This should generate continued jobs growth and a further fall in global unemployment rates.
Nonetheless, the risks remain firmly tilted to the downside and we are probably now moving to the late stage of the global cycle. In the current environment, the danger is that markets could turn sooner rather than later. The biggest immediate trigger for global downturn remains China, where policy-makers seek to steer the economy through a difficult transition towards slower, more sustainable growth.
But provided China remains stable, the more enduring challenge facing global real estate markets is the outlook for long term interest rates. While sustained low interest rates have been crucial to the recovery, there are concerns that they are starting to distort global asset markets. Nowhere is this clearer than in real estate; global property has enjoyed a number of strong years, boosted by a steady compression in property yields. But with limited scope for yields to fall further, total returns are expected to slow and markets are increasingly susceptible to even small shifts in sentiment. While 2016 should be another positive year for global real estate returns, they are probably past their peak for the current cycle. Investors should be wary of chasing yields lower in 2016, as these may end up being the deals most regretted when the market eventually turns.
Long-term drivers of global real estate returns
Beyond these short-term cyclical concerns, real estate investors are also grappling with a number of forces that are starting to cloud the long-term investment outlook.
Throughout 2015, Grosvenor’s research team spent significant time examining the major themes (‘megatrends’) that are shaping the long-term outlook. Our research suggests that we are entering a key period of large-scale change across a range of fronts. Specifically, three major forces will fundamentally reshape the world over the next 30 years:
(1) the application of new digital technologies;
(2) the negative impacts from climate change; and
(3) large-scale demographic change.
While each factor is significant in itself, the fact that all three shifts are occurring simultaneously is unprecedented. These forces are already shaping several major realignments in the global landscape, including: the continued shift in economic power towards Asia; the continued rise in the importance of cities; and increased job insecurity and income inequality.
Clearly, the pace and scale of these long-term changes is daunting; we are moving rapidly towards a digitally-disrupted, post-carbon world, with extraordinary demographic changes. But these tectonic changes in the global economy will bring new opportunities as well as risks. Long-term success will require investors to adapt to new markets and new sectors, adopt new business models and explore new ways of thinking about real estate.
For more, please see our Annual Review 2015.