Emerging Trends In Real Estate - PwC

Another interviewee comments: “We’re stillnot seeing the uptick in supply that youwould expect. And that has to do withbanks being much stricter in what they’reasking for when it comes to speculativedevelopment loans. In fact, in manycountries they are still not really availableat reasonable margins, and that helpsthe market to stay in sync.”Not surprisingly, however, investors arediverting their search for secure, long-termincome into alternative real estate sectors.Debt is increasingly seen as a safe meansof exposure to the sector – nearly fourfifths of respondents to the EmergingTrends Europe survey expect non-banklenders to increase their activity in 2018.There is another dimension to the relativeattraction of debt finance, and that comesfrom the recent tightening up of the capitalrequirements for banks, known as BaselIV. The reaction from the banking sectorhas been positive although that is partlyto do with the long phase-in period forthe new regulations – they will not takefull effect until 2027. Much will dependon the interpretation of Basel IV bynational regulators.In both Europe and the US, meanwhile,there is a shift by some investors tosecond-tier cities away from the expensivemajor markets. There is a clear distinction,though, between second-tier andsecondary. Rising stars – such asCopenhagen and Raleigh/Durham –are lauded for their diverse economies andskilled workforces as much as affordability.“You certainly get the sense that whencapital starts to move laterally to lesstraditional asset classes to find value,or when it starts to move laterallygeographically, these are usually thesymptoms of a late cycle,” observesone global investor. “The big differencefrom a financing point of view is thatfunding costs are still quite low, and that’swhat makes it easier for investors to waitit out a bit longer.”6Rising interest rates and‘no more easy money’With growing economies come risinginterest rates as a check on inflation, andthe expectation of more to come, at leastthis year in the US and the UK. ContinentalEurope is further behind although theEuropean Central Bank has signalledthe end of its asset purchase programmeby the end of 2018, and rate rises areexpected to follow in 2019. “No moreeasy money,” says one interviewee.Rising interest rates – and inflation –are now on the agenda for real estate.There is nothing like the anxiety thatprompted a huge sell-off in globalstock markets in January this year.The expectation among Europeaninterviewees for Global Emerging Trends isthat it will be one to two years before risingrates exert a major influence on real estatemarkets. It would be hard to describethe interviewees for this report ascomplacent, however.“Over a ten-year view, we expect yieldsto move out, but they could very easilygo down further before they go up,”says a global investor. “It really dependson what happens with regard to monetarypolicy. At the moment the US is tightening,the UK is clearly likely to do so in May, andthere are signs that Europe might follow.”As for Asia Pacific, another global playersuggests that inflation pressures acrossthe region are not as strong as in the USand Europe. “And in [Asia Pacific] realestate markets generally there’s a goodspread between yield and cost of money,so there’s a built-in shock absorberoffsetting the impact of potential interestrate increases.”Emerging Trends in Real Estate The global outlook for 2018However, one European intervieweeobserves: “My first guess was that theraising of interest rates would take longer,but it has happened more strongly andglobally than expected. This is going tobe the caveat to the solid growth weare experiencing here.”There is another caveat, and that’spolitics. Brexit casts a long shadow,still, but national elections in the US,The Netherlands, France and Germanyhave come and gone, leaving propertymarkets unscathed and economiesgrowing. Notwithstanding the outcomeof the Italian election in March this year,there is a sense of the industry taking adeep breath after all the political noiseof 2016 and 2017.Even so, with the major global investorsincreasingly thinking long-term – and wellbeyond the current property cycle – thepolitical backdrop to real estate is still atthe back of their minds. “For most of mycareer in Europe, we’ve not spent a lot oftime worrying about politics. That’s oneof the things that is so different,” says oneglobal investor. “We’re now in a scenariowhere something like 1 percent of theworld’s population are controllingan enormous proportion of the wealth.With that imbalance, politics is goingto become more and more importantgoing forward, and that will bringpotential volatility.”

Maintaining balanceUS – smaller cities rising,taxes fallingInvestors completed a total of 375.6 billionof transactions greater than 10 million inthe US during 2017, an 8 percent declinefrom 2016 and the second successive yearof falling investment, according to RCA.The slowdown in activity reflected areassessment of pricing throughout theyear in the major cities following the USFederal Reserve raising interest ratesthree times, with the expectation offurther increases in 2018.Investment tumbled by 32 percent inNew York City during 2017. Of the 14 USmetro areas ranked in the top 30 globalinvestment destinations, RCA says onlyWashington, D.C., and Houston registeredstronger activity.The investment numbers also indicatean ongoing investor appetite for smallermarkets, as highlighted in EmergingTrends US and Canada. More selectivethan before, investors are increasinglydrawn to cities such as Salt Lake Cityand Raleigh/Durham for their relativeaffordability and skilled workforce.Such a focus is not new – it is reminiscentof the shift in investor interest in the2005–2007 period – but the staying powerof secondary markets may be, not leastbecause they have avoided the level ofoverbuilding seen in previous cycles.As one Emerging Trends Global intervieweecautions, though, investors must resist“a broad brush” approach to how theyassess the smaller cities. “We’re workingvery hard not to make the mistake of thepast and go to secondary and tertiarycities simply to chase yield at the wrongpoint in the cycle. But instead we’re veryfocused on what I’d call second tier citiesthat demonstrate really strong economicgrowth prospects and include wellestablished institutions, whether medical,educational, or governmental, whichstabilise those markets. We’re trying to bevery tactical and chase markets that exhibitstrong fundamentals, which should makethem more attractive places to invest.”In any case, major and second tierreal estate markets alike are destinedto prosper from what has been heraldedas the most sweeping US tax reform indecades. President Trump’s long-awaitedTax Cuts and Jobs Act was finallyapproved by Congress in December2017, and many US property playersbelieve the market could feel the benefit,possibly as early as this year.“The tax changes havehelped create someclear momentum.There are good reasonsto be optimistic on theUS despite the politicalnoise, although largechunks of that arealready in the price inequity and real estatemarkets. But a degreeof caution is warrantedgiven the fact that weare in the eighth orninth inning, to usea baseball expression,of the cycle.”Global investor,Global Emerging Trends in Real Estate 2018Emerging Trends in Real Estate The global outlook for 20187

Figure 1-2 Do you think the new tax law will be good for real estate?Figure 1-3 The new tax law will begood for 706061.0%24.7%25.8%503.4%40%32.2%3046.1%20Space demand100Operating costs6.9%Investment economicsInvestor demandYesNoUnsureSource: Emerging Trends in Real Estate 2018 Mid-Year SurveySource: Emerging Trends in Real Estate 2018 Mid-Year Survey“Rising interest rates havebeen well telegraphedby central bankers, andwe’ve been looking atspreads since late 2016.The only difference nowis that we’ve had threerate rises in the US, sowe’re in that process, butit’s not something thatspooks us. Given whereyields are now relative tothe cost of money, wehave the ability to absorbmodest increases.”Global investor,Global Emerging Trends in Real Estate 20188According to the Emerging Trends 2018mid-year survey conducted in the US,61 percent of respondents believe thenew tax law will be good for real estatealthough nearly a third are unsure.Around a quarter of respondents saythe tax reform will boost investor demand,and a similar number say it will improveoccupier demand.The full impact on commercial real estateremains to be seen but the three mainfiscal levers are: foreign investors will beable to invest and repatriate profits moreeasily than before; US companies thatuntil now parked some of their profitsoverseas at lower corporate tax ratescan repatriate those earnings into the US;and a reduced corporate tax rate in theUS. As one Emerging Trends Globalinterviewee observes of the latter tworeforms: “You would presume some ofthose accumulated earnings and taxsavings will lead to the expansion ofcorporate America, which will spill overinto increased demand and take-up ofoffices and industrial space.”Emerging Trends in Real Estate The global outlook for 2018“In 2017, there was a lot of talk aboutthe late cycle and pricing bubbles,and concern that the end had to benear,” adds another interviewee.“What’s shifted over the last six monthsis the boost provided by the tax cuts,the continued strength of the USeconomy, the continued strength ofthe global economy. The conclusionis indeed we are at a late point in thecycle, but it’s certainly being extendedby those factors.”

Maintaining balanceEurope – renewed optimismin the core economiesEurope’s property industry is “cautiousbut positive”, drawing comfort fromthe fact that the European Union (EU)economy is growing at its fastest pacein a decade, which in turn is supportingoccupier demand as well as investment.Figures from the EU statistics officeEurostat show that the EU grew by 2.5percent in 2017 – its strongest performancesince 2007 when it grew by 2.7 percent.In the final quarter, both the EU and the19-nation Eurozone grew by 0.6 percentcompared with the previous quarter.Much of the growth has been driven bythe core economies of Germany, France,Italy, and Spain, which has reassured theindustry leaders interviewed for GlobalEmerging Trends. “The demand side isimproving, and we’re seeing rent increasesin most product types,” says one. “We don’thave retail rents going up, but we do haveoffice rents rising in most markets in Europe,and you certainly see logistics rents rising.We think that’s going to continue.”Against that backdrop, Europe registered 314 billion of investment sales in 2017,according to RCA, and the transactionswere many and varied, from majorportfolio deals to corporate mergersand acquisitions, as well as large singleproperty sales – particularly in London.Led by Germany, each of Europe’s fivelargest markets for commercial real estateinvestment reported higher volumes than2016, RCA data show, with the Netherlandsand Spain setting new records.For European property professionals,it is hard to dissociate London from thecontinuing uncertainty around Brexit,which is why the UK capital languishesat the lower end of the Emerging TrendsEurope city ranking

use of real estate. The time-frame for building obsolescence has become squeezed as a result of changing occupier needs and a greater information transparency. In effect, new supply is being created by technological developments in areas such as co-working and hospitality. Real estate is continuing to evolve into something that is less about ownership and more about access – or services and .