A small number of cities are responsible for a large proportion of global capital flows–the top five cities account for 43% of the total and the top ten cities account for 58%. These cities are characterised by scale, liquidity, transparency and a low cost of debt–all vital components for global asset allocators. London is ‘the poster child’, the recipient of 20% of all global cross-regional investment flows into commercial real estate.
Assets managed by institutions have grown strongly over the past decade and by 2020 we expect this figure to be close to €200 trillion. A rapid rise in the middle class is partly behind this trend which is forecast to hit 3.84 billion people by 2020. A massive 88% of the next billion entrants will be from Asia, a region of savers who are expanding this growing pool of institutional capital.
Where will this money go? Global allocations to real estate are growing with institutional targets at 10.3% on average. American institutions are already allocating this level of capital and more, but the Asian institutions are underweight. Asian investors, who were previously tied to their domestic market, are starting to look at the global markets to address under allocations. By 2020, we estimate that $11.4 trillion will be allocated to real estate globally.
Some evidence points to institutions’ growing concern about real estate as an asset class. Rising interest rates are the main cause of apprehension concern but with inflation falling across most major economies, except for the UK, fears about further interest rate rises are easing–all good news for the real estate sector. Our view is that quantitative easing (QE) is likely to unwind very slowly when it does and its implications on the long end of the curve are not a major worry. In fact, a case can be made for a rewinding of QE which will have further positive implications for pricing.
Then there is the cycle. We are a long way through, but there is perhaps further to go with many believing unemployment levels still have some way to fall. Consequently, we could be looking at the longest cycle on record. Office yields relative to bonds also continue to stack up.
Deploying capital is the biggest issue. Investors faced by a shortage of stock in some of the major markets are forced to delay investment decisions as owners take advantage of cheap and plentiful debt to refinance rather than sell.
In any case, gateway cities will always prevail. They preserve value in the long term and the defensive characteristics of real estate, rooted in long income streams should not be forgotten. In London, 2017 has proved to be a robust year for inward investment, dominated by overseas capital. Investment transactions totalled £4.8 billion in Q3 2017 taking the year to date total to £13 billion, on par with the full year total for 2016. Overseas investors continued to dominate on the buyside, accounting for 94% of the market. Asian buyers were the largest investor group representing 68% of all office transactions and making it the highest quarterly total for Asian investment on record.
While real estate faces challenges, so do other asset classes and I believe the weight and cost of capital looking at the sector is likely to prevail. Asian capital remains grossly underallocated and given the lower returns they require on their investments, I believe they will continue to underpin the real estate market going forward.
By Adam Hetherington, Managing Director, London, CBRE.