As core real estate pricing climbs past prior peaks in key global gateway cities due to a shortage of supply and strong demand, investors should focus on generating income from quality buildings and tenants.
“Concentrate on income in 2017 because trying to generate significant capital growth is going to be difficult given current pricing”, says David Green-Morgan, Global Capital Markets Research Director at JLL. “The quality of the building and its location will be important factors to consider as well as the quality of your tenants. You should also be aware of the dynamics that your tenants are going to face in the coming year in terms of workforce expansion or contraction and increasingly the global political environment.”
Globally, the development pipeline continues to be relatively weak. Banking regulators and new risk regulations have enforced discipline on commercial lending, a primary factor in the slowdown in development and construction. In some areas construction costs have also risen.
“Development always involves higher risk and you see the lenders continuing to shy away from financing development,” says Green-Morgan. “If the economy does expand as predicted this year, we will definitely run into a situation where there will be a shortage of space in a number of locations around the world and rental growth will increase quite rapidly in that scenario.”
While markets in 2017 will continue to be influenced by political risk, with elections in France and Germany in the spotlight, Green-Morgan does not view such events necessarily as negative. “These political events while important, in terms of the way that they influence the macro environment, can provide investors opportunities in the short term as well. We saw property stocks drop significantly after Brexit and in the United States around the elections.”
Following a tumultuous 2016 driven by the unexpected outcomes of the Brexit referendum and the U.S. Presidential elections, global real estate deal volumes for the year fell eight percent in the Americas and nine percent in Europe. Asia Pacific was the only region to see an increase in transactional activity, rising by five percent, bringing the full-year global volume to US$661 billion, a six percent decline from 2015. JLL is expecting transaction volumes in 2017 to reach US$660-$700 billion.
The United States offers upside potential
Despite concerns about the Trump presidency, international interest in U.S. real estate remained unabated, according to JLL. “They has been a lot of rhetoric about ‘America First’ and trade wars but certainly in discussions we have had, people are just as keen, if not more keen now, because they think that if Trump really turns some of these policies into reality, then the United States will see economic growth,” says Green-Morgan. “This year, the United States is possibly the country with greatest upside potential, compared with other developed economies. While Trump’s foreign policies have caused concerns, his “America First” inaugural address resonated with voters, and his plan to spend US$1 trillion dollars updating and improving aging U.S. infrastructure is expected to benefit the domestic economy.
However, a follow-through of his election promise to boost infrastructure spending and ‘make America great’ may create inflationary pressure, which will drive up interest rates at a much faster rate. “That would be damaging because real estate yields have compressed to historically low levels and they have only just started to move out,” says Green-Morgan. “A rising interest rate environment without good strong economic growth is never a good scenario and would leave some real estate investors quite exposed.”
Among potential buyers, Chinese capital will continue to play a dominant role. “The Chinese are now, alongside the Germans and the Americans, the largest movers of capital globally,” says Green-Morgan.
Last year, China invested $33 billion in global real estate, up more than 50 percent from 2015 levels. Significant transactions include the purchase of Strategic Hotels and Resorts by Anbang Insurance for over US$6 billion; China Life Insurance’s portfolio purchase of the Starwood Capital Group and an office tower in Manhattan; the HNA Group completing its acquisition of Carlson Hotels and a 25 percent stake in Hilton Worldwide.
In Asia, Green-Morgan also expects increased activity from Japanese buyers. Japan’s GPIF, the world’s largest pension fund, has said that it plans to increase investment in private equity and infrastructure in 2017 and start investing in real estate to boost returns. In Europe, French institutional capital has been active alongside Middle Eastern buyers. “We should continue to see the trend of more money coming into real estate with all types of companies, particularly insurance firms and sovereign wealth funds, wanting to raise their allocations,” says Green-Morgan.