Real estate fundamentals are expected to remain solid in 2019, despite the market’s late cycle, rising interest rates and structural change disrupting the industry, most notably the retail sector. Positive global growth forecasts and an overall balance of supply and demand continue to support net operating income and property values. Commercial real estate continues to attract new capital, with stable income returns generally exceeding those available in fixed income. However, little or no capital appreciation can be expected, and putting new capital to work will be challenging in 2019.
Structural change driven by demographics, technology and consumer trends are creating opportunities to add alpha. We expect global cities benefiting from advanced technology, sustainable development and rising urbanisation to outperform through the next market cycle. The upheavals impacting office and retail are generating demand for high-tech buildings with flexible office space and light industrial warehouses. We believe some of the best opportunities exist in alternative sectors, such as data centres, purpose-built student housing or manufactured housing.
Globally, residential apartments are benefiting from strong demand among middle-income families and millennials priced out of home ownership. Global real estate debt’s stable income returns and lower volatility offer risk protection for real estate equity portfolios.
Risks to the outlook include underestimating the need to ‘future-proof’ portfolios by incorporating exposure to emerging new sectors, and ‘future-proofing’ buildings through the smart use of technology to ensure they remain relevant and sustainable. Sustainability will be increasingly important to occupiers, investors and consumers alike and will have a significant impact on the attractiveness of buildings.
We favour investing in 90 global cities offering scale, growth, sustainability and resilience. Sector wise, we favour real estate debt, logistics, apartments, student housing and manufactured housing.
The office sector is undergoing a structural upheaval which will continue in 2019 and beyond. Co-working trends have been the talking point of 2018. The expansion of WeWork, and other collaborative work space operators, has boosted demand in major cities across the globe and should continue to do so in 2019. Tomorrow’s world offices will need to be flexible, cost effective buildings that generate positive externalities through collaboration and knowledge sharing.
Millennials and Generation Z will comprise 75% of the developed world workforce by 2035, and they are already driving significant change in the office sector. These generations demand flexibility and agility in terms of when, where and how they work and place a huge emphasis on collaboration and knowledge sharing. As a result, the office sector has been undergoing structural transformation and this is expected to continue to evolve in 2019 and beyond. Offices therefore need to be flexible, cost effective and able to generate positive externalities for their occupants. Flexible office operators were the talking point of 2018, engaging in a race for space and characterised, in particular, by the highly-acquisitive leasing programme of WeWork. These operators have boosted leasing demand in major office centres across the globe. It will be interesting to see how flexible space fares when the business cycle becomes less supportive, but for now it is clear that the recent trend will continue, supporting rental growth in selective markets.
Core assets in established locations, or improving locations in established cities, should prove resilient through the next cycle. Investors with office portfolios which focus only on global gateway cities may not benefit from geographical diversification – their performance tends to be closely correlated with advanced nations’ economic growth. Real estate in cities with broader-based economies, which are less responsive to global financial conditions, should prove more resilient in the event of a global slowdown.