Cross border and domestic capital to increase allocations to global real estate

LONDON July 27, 2015 – Cross border and domestic capital will continue to expand its allocation to global real estate as a result of the benign economic environment, according to LaSalle Investment Management’s Mid-Year 2015 Investment Strategy Annual (ISA).

With interest rates remaining lower for longer, benchmark bond and real estate debt costs remaining low, and a steady, cyclical recovery underway around the world, real estate values continue to prove attractive. The secular themes of demographics, technology and urbanization (DTU) also continue to drive demand for space in specific areas.

LaSalle’s twice-yearly ISA looks at investment trends around the world and highlights the best investment opportunities going forward. Globally, both overseas and domestic investors are likely to expand their real estate allocations due to:

  • The stable income produced by core assets generating yields at a healthy premium to sovereign and corporate bonds
  • Real estate being grounded in valuation metrics like replacement cost that are elusive in other asset classes, at a time when all asset prices are high,
  • Real estate’s low covariance with other asset classes providing diversification benefits
  • An investor’s ability to create wealth by developing and leasing buildings producing a reasonable risk-reward proposition in a rising market

Jacques Gordon, LaSalle Investment Management’s global head of research and strategy, said: “At the end of last year, we identified the cyclicality of real estate as our main theme. Since then, a number of the cyclical trends have played out even faster and more intensely than we gave them credit for.

“The cycle question weighs heavily on our minds as we anticipate a very active buying and selling season in the second half of the year. The best “cycle insurance” we can recommend is to keep leverage levels at the conservative end of the acceptable range, and to choose investments that will continue to get a boost from secular shifts, even if cyclical trends turn negative. Investors should avoid compromising on asset quality and stick to deeper tenant markets as we enter the late stages of the value cycle. When a property’s ability to attract tenants is compromised in a recession, weaker properties in smaller markets nearly always suffer the greatest drops in value.”

Some of the key regional themes the ISA has found include:

Europe

LaSalle has revised upwards its rental growth forecast for the region thanks to the underlying improved fundamentals and the fact that oversupply risks are in check in most markets. Other themes include:

  • In the UK, investors should focus on assets linked to DTU themes including improved infrastructure and demographics, a lack of obsolescence, and locations where tenant demand will be rewarded by increased rents in the short term
  • Also in the UK, residential through forward-funding of private rented sector (PRS) buildings is appealing
  • Direct-let student housing continues to offer attractive entry yields
  • More widely, investors seeking to expand their core and core+ portfolios should focus their attention on dominant or hard-to-replicate shopping centres in cities such as London, Paris, Berlin, Munich and Amsterdam

North America

Real estate fundamentals and prices continued to improve in the United States in the early part of this year, but were flat or down in Canada and Mexico.  Even with interest rates edging up, unleveraged US core real estate remains fairly valued relative to bonds and other fixed income alternatives. Themes to consider in the current climate include:

  • Occupancies in better buildings in better markets will stay fuller in any downturn, and remain good long-term investments
  • Value add and build/renovate to core strategies remain attractive in the US with near-term execution.
  • Warehouse development will benefit from stronger user and investor demand
  • Areas with improving transit and infrastructure including Los Angeles, Denver, Washington and New York are best placed to benefit from DTU-linked themes
  • Industrial remains the top pick in Canada

Asia

The region’s relatively robust demand conditions and low interest rates are supportive of the real estate market. Foreign institutions are gradually increasing their allocations to Asia, while domestic and regional investors remain active, meaning it will remain a competitive environment to allocate capital.  Other significant trends the ISA found include:

  • Selective types of retail in Australia and Japan, specifically neighbourhood or sub-regional and suburban respectively, are the main highlights
  • In China, LaSalle recommends logistics development, although they remain hard to access Also investors should consider buying into tier-1 city offices to benefit from the country’s long-term growth story
  • In Japan, LaSalle’s top higher return strategy remains value-add, particularly in office