29 Jul The global environment for real estate investment
Many of the trends that shaped the investment landscape in recent years – low inflation, quantitative easing, and weak western economies – are set to go into reverse. Property investors need to separate the economic signals from the political noise and understand these changing dynamics.
In its latest forecasts the International Monetary Fund (IMF) revised its predictions for global GDP to 3.5%; up from 3.1% in 2016.
Advanced economies are expected to lead this growth, with a more subdued recovery seen in emerging markets. The G7 leading industrial nations are forecast by the IMF to see 1.8% growth in 2017, compared to 1.4% in 2016, with the US leading the pack. This is because the advanced economies have largely worked out their debt excesses from the 2005-2007 period; whereas emerging markets are still experiencing the consequences of over-investment in 2010-2011.
This arguably puts the next cycle for the global economy on a firmer footing. The period 2010-2011, when emerging Asia was performing strongly while the advanced economies struggled, was a time of economic unreality. How could the exporters be booming when the importers they sold to were mired in a slowdown? Effectively, refugee capital from the west was fuelling a bubble that inevitably deflated, resulting in slowdown and currency volatility.
However, the consumer countries of the west are now delivering stronger growth, and the exporter nations will feel the benefits over the long-term. As the wealthy nations gain economic momentum, and consequently start to raise interest rates, exchange rate movements should boost the exporter nations. Indeed, in the case of the US and its trade relationship with emerging markets, this is already occurring. Over the next few years, other advanced economies will join the US in seeing their currencies strengthen as the interest rate environment begins to normalise.
For many of the advanced economies, particularly the larger and more dynamic ones such as the US, UK and Germany, unemployment rates are low and consumer spending robust, just as we move into this period of rising growth and currency appreciation. So for consumers in these stronger western nations, growing job security and imports becoming cheaper will more than off-set any rise in interest rates, and we can expect continued momentum in consumer spending; ultimately benefiting exporter nations in emerging markets.
Moreover, strong western currencies and weaker commodity prices will influence the cross-border investment narrative. Between 2010 and 2016, we became very used to emerging market money flowing into the advanced economies, particularly in the real estate world. From 2010 to 2014 this was enhanced by strong emerging market currencies; from 2015 capital flight has been at least part of the motivation.
The evolving narrative for 2017 and beyond will have three principal lines. Firstly, advanced economy investors will want to use their stronger currencies to buy into emerging markets.
Secondly, emerging-market capital will steadily find more reason to invest at home; through a combination of overseas markets appearing expensive for currency reasons, and domestic economies moving into recovery.
Thirdly, as economies such as the US raise interest rates, financial institutions in nations with much lower rates, like Japan, will move money to American banks. As the money piles up on the balance sheets of those banks, pressure will grow to lend, so we could see in countries like the US the paradoxical situation of rates rising, but appetite for real estate lending increasing.
Back towards a ‘normal’ cycle
As a result, we expect to see the global economy move into its long established cyclical pattern. Low growth, saver nations like Japan will extend the credit for consumer lending in economies where higher levels of growth and easier attitudes towards spending provide a market for debt. A strong domestic currency makes foreign imports temptingly priced, thus further oiling the wheels of consumerism. Robust cash flow and full order books then encourage companies in both advanced and emerging economies to invest in new capacity.
The process starts sensibly, underpinned by conservative regulation. However, as we move further away from the crisis years, and pressures to increase market share increases, less wise decisions are made. Attitudes towards regulation loosen – in fact, we are already seeing this now, with talk of rolling back the Dodd-Frank Act in the US. Five to seven years from now, the global economy will probably be ripe for another downturn.
Real estate has further to run
However, the key point for property investors is that we see this next correction as being several years down the line. The global economy is moving out of a period of wound-licking, but has not yet built up the excesses that typically lead to a downturn. Given we are, in our view, not at the end of a cycle, in 2017 property investors need to be thinking of growth locations and value-add strategies. These will offer the best means of gaining exposure to this latest evolution of the market cycle.
Source: Knight Frank