The prime yield compression stage of the property investment cycle has either completed, or is close to the end, in the leading global cities. However, tight development pipelines over several years have created leasing supply crunches, particularly for offices and logistics property.
This is coinciding with stronger occupier demand. We see the search for returns pushing investors up the risk curve to pursue refurbishment and development opportunities; or diversifying into the specialist sectors.
When judging the outlook for global property markets in the next few years, the forecaster encounters contradictory signals. The International Monetary Fund (IMF) is predicting worldwide GDP growth to decelerate from 3.7% in 2018 to 3.5% in 2019.
This suggests a year of continued expansion, just at a slightly reduced pace. However, financial markets are currently volatile and concerned about the outlook, as leading central banks are expected to tighten monetary policy next year and beyond.
The risk for the global economy is that policymakers may hike rates too aggressively and derail growth. Moreover, the US is ready for higher rates, but is the same true of those economies who peg their currencies to the dollar? After all, China’s economy appears to be slowing.
This creates a double risk for a number of nations in the Middle East and Asia who now have economies that are significantly exposed to both the US and China.
The rollercoaster ride for equity and bond markets are also symptomatic of wider concerns. Geo-political risks abound, from the Brexit saga in the UK, to the trade confrontation between the US and China, to fresh storm clouds gathering over Italy. After years of buoyant expansion, the tech sector faces widespread concerns over the sustainability of its rapid growth.
What will all this mean for real estate in the coming years?
Often the property world views a rising interest rate cycle with too much dread. Rate hikes will increase the cost of debt, although no central bank wants to slow lending to the point of causing a downturn. Policymakers look to curb excess while allowing sustained growth.
The Bank of England steadily raised interest rates from 2004 to 2007, but commercial property yields hardened. This was because a buoyant occupier market, and the resulting rental growth gave property investors the confidence to buy.
Higher interest rates will cause money to flow into banks, which they can earn more income on by lending to the wider world than purchasing government bonds. Under pressure from the finance director to lend, origination teams will extend more finance to property investors in the coming years.
"If workers are in short supply, companies will use automation, artificial intelligence and machine learning to free up people for higher value tasks. This will fuel the tech revolution further, and create more of the start-up firms who flock to the coworking centres.”
Improving expectations on rental growth should give more investors the confidence to make leveraged buys, particularly given the supply problems found across global occupier markets.
We see this being particularly the case in the coming years, as financial markets have often over-estimated the pace at which monetary policy will tighten, while the property world has under-estimated how quickly leasing supply is eroding.
The temptation to buy vacant properties for a quick refurbishment is likely to be high in nearly all the key global cities, due to years of constrained development and lots of pre-letting. A common theme emerging when researching this report was that vacancy rates are falling, partly due to the pipeline issues already mentioned, but also thanks to rising demand.
War for talent
More investors will have the confidence to pursue strategies involving rental growth because, in the cities covered by this report, so many of the necessary ingredients for higher rents are in place.
Rapid expansion by technology firms and coworking operators are a recurring theme around the world. Typically they are seeking high quality, well located offices, as employers want wow-factor offices that promote staff satisfaction and collaborative working.
This reflects the fact that so many major economies are either at or close to full employment, creating a battle among employers for the best workers.
We see wage inflation picking up in 2019, and alternative ways to retain staff, like providing an exciting work environment, will appeal more to corporations in this context. Demographics are behind the growing staff shortages, and the political backlash against immigration across the world will deepen the problems of occupiers trying to recruit talent.
If workers struggle to move geographically, the jobs must go to them, and we see corporations becoming more global, plus venturing into tier two cities looking for staff. That these locations can potentially offer staff a better quality of life, through lower house prices and shorter commutes, will add to the appeal for firms expanding their office networks.
Oxford Economics are forecasting financial and business services employment in the cities covered by this report to increase by 2.6 million jobs between 2019 and 2021. This could mean office demand increases by 287 million sq ft; the equivalent of more than three times the office space found in Singapore.
Moreover, if workers are in short supply, companies will use automation, artificial intelligence (AI) and machine learning to free up people for higher value tasks.
This will fuel the tech revolution further, and create more of the start-up firms who flock to the coworking centres. Also, greater use of IT in scientific R&D is drawing more jobs in industries like life science into city centres, adding a new dimension to the tech wave.
Inevitably, this brings us back to the stock market wobble for tech of late. This is undoubtedly a significant risk for the outlook, although compared to the last big tech industry correction in 2001, there is a larger share of profitmaking firms who have been trading for years (or decades) rather than months.
Moreover, there is evidence that tech is creating an economy all of its own – of services that exist because of the presence of tech – from online fraud prevention, to cyber security, to the battle to curtail fake news.
Overall, we believe there is a compelling global case for continued central growth across the Global Cities. This is equally true of those locations that face the political rollercoaster of populism, as office rental growth has been in evidence in some US and UK cities in 2018, undaunted by the Trump presidency and Brexit.
Buildings with beds
Around the globe, occupier and investment demand are adjusting to the changing landscape of how we shop. E-commerce has boosted demand for logistics property, but left many older shopping centres with empty units that can be hard to fill.
This is a global phenomenon that requires property investors to adapt fast. Developers are seeking locations for suburban warehouses for local deliveries.
Shopping centre owners are considering radical redevelopment plans to replace some of their floor space with other uses. This has moved beyond leisure uses, with hotels and residential property entering the mix.
This is one reason why the expression ‘buildings with beds’ is rising in popularity in the real estate world, as the mix of property uses evolves to reflect societal needs and consumer lifestyles.
Buildings with beds come in many forms, with care homes and retirement living reflecting the ageing population phenomenon which is becoming a pressing issue across geographies.
As developing economies become wealthier, more money becomes available for higher education and holidays, driving demand for student accommodation and hotels. Moreover, flexible lifestyles, plus affordability issues, are pushing private rented sector housing up the property agenda.