Predicting the future is nearly impossible. At best, we can assign probabilities to certain events based on our limited understanding and knowledge of the variables that impact certain outcomes. Yet, it still seems one of the favorite sports at real estate industry events, and one that the ULI Spring Conference in Seattle earlier this month tackled, as well. The experts’ prognosis concluded that we are in an extended play territory (depending which sports analogy you prefer, it may mean extra innings, or bonus time) with a fairly disciplined industry facing some economic headwinds that should be addressed.
“If you are a European investor, a core investor, our universe is shrinking terribly,” said Martin J. Brühl, chief investment officer of the Hamburg-based Union Investment Real Estate GmbH. Brühl described the investment landscape across the globe, and the important role the US market holds for large institutional investors. Peripheral Europe (Greece, Portugal, Spain) is high risk for economic reasons, and in certain countries the debt crisis is not over, he said. Even the United Kingdom is no longer safe following Brexit. “They may tell you differently, and show stats how foreign capital comes in, because the pound has lost in value, but it’s actually a shrinking universe,” Brühl said. The United States offers jobs and economic fundamentals that outperform most other global economies, he stated.
As a result, investors like Union are starting to look into secondary markets, because in relative terms, they offer the safety and liquidity other large cities around the globe cannot. “So, we’ve started to really go into secondary cities. We like Austin, for example, Minneapolis, not the kind of usual gateway cities approach, which a German investor would take in the US. We’ve gone down the hierarchy of urbanization, and we’re very happy with that. So, we do believe in the US, it is the safest haven,” concluded Brühl.
Janice Stanton, a 25-year veteran of the industry and a senior managing director in the Capital Markets group at Cushman & Wakefield in New York, concurred. She pointed to her experience meeting investors from around the globe and finding a similar thread of reasoning: The number of markets where they are ready to place funds has shrunk, and the allocation of investment dollars is now based on yield more than before.
“A lot of the international capital, it no longer looks at X percent for the US, and Y percent for Europe, it’s really looking at what can I get in yields in London vs. New York vs. Frankfurt vs. Munich vs. San Francisco. I almost think we’ve become city states in some sense from an alternative investment universe,” said Stanton
However, while that explains one aspect of the equation, the demand of an international investor, other variables are at play, as well. The length of the present cycle is one of them, and asset appreciation can only go so far according to Greta Guggenheim, partner and president of the Mortgage REIT at TPG Real Estate Finance Trust.
“Asking prices are pretty high right now. I think owners of US real estate got used to ever-lowering cap rates and increasing prices, and they’re just going to have to adjust their expectations,” she said. Guggenheim added that the market is close to 30 percent above pre recession peak pricing, and no one wants to take that pricing to 50 percent or higher.
“Core will come down slightly, because it’s not sustainable, but the secondary stuff, the regional secondary cities’ stock will actually become more expensive,” added Brühl. The more sophisticated the investors get, the higher the demand for those assets and as a result yield compression, as well.
Another important variable has been the presidential election in the US. Overall it has had a positive effect on the economy, according to Guggenheim, but time will tell if that will last.
Michael D. Thomas, senior managing director of PNC Capital Markets sees it tied to confidence in the economy. “[Trump’s election impacted the] unlocking of the confidence that people have in the economy that may have been suppressed by some of the regulatory environment,” Thomas said.
Janice Stanton’s offered a measurable impact saying that the policies, or their announcement, have added at least 1/2 a point to the gross domestic product and roughly 2 years to the economic cycle. Especially interesting has been the announced investment in infrastructure upgrades, and a lot of her clients are asking how they may be able to participate in that investment.
However, Brühl offered a slightly less sanguine perspective. “The election of Donald Trump as the most powerful individual on this planet is scaring me to death and keeping me up at night,” he said. From an international investor’s perspective, he sees Trump’s policies to curtail globalization and increase nationalism worrisome for Union’s $5.4 billion investment in the US real estate market. He added that Union is watching this carefully and with some concern.
Thomas added that a lot of people would agree with that sentiment, but that it has been difficult for the market to price for that risk. “This [cycle] has been extended for maybe another couple of years, but we’re never able to predict when the [new] cycle is coming,” he said. “There are some things that are concerning out there, the aging population, the productivity slowdown, those sorts of things are real.”
Guggenheim agreed, “We’re already seeing a flattening of the yield curve, which is not a good prognosis for major growth. On the negative side, we have an aging population and low productivity, and that combined with the rising interest rate environment is not great from an economist’s view point.” However, she sees more risk to the economy as well as the industry coming from the oversized Chinese global influence. China represents close to 30 percent of global trade today, she said, and if something happens there, it definitely shakes up the market like it did in early 2016.
“If you go back to the first quarter of 2016, the major disruptions we had were caused by China. And I can see that being the future cause. Their credit is overextended, they just replaced their head bank regulator to try to rein in credit, but he’s not going to do anything because the People’s Congress in October-November of this year and until that’s passed,” Guggenheim said.
So, what measures could help prevent that or soften their impact? Brühl suggested “A boost to the US and global economy would be mixture of first moderate and wise deregulation of capital markets, secondly moderate and wise and well-thought through economic stimulus, and thirdly and opening of borders and a reduction of trade tariffs, because that is going to be a win-win globally.”
He concluded, “If you have these three things together, not just the two, and not just opening borders and not going for an economic stimulus and de-regulation, … but if you have a combination of these three things that would be a positive surprise, really an upside event.”