Global real estate returns have finally seen a positive turnaround in the second quarter of 2024, hinting at a potential recovery after two years of cumulative losses. The era of low interest rates has boosted real estate values, with global total returns reaching 5.0% q-o-q in 4Q2021 and 17.8% y-o-y in 1Q2022 – exceeding long-term averages. However, the subsequent tightening cycle has erased these gains, bringing values back to 2018 levels globally. We believe that the market correction is nearly complete, making it a favorable time for investors to consider this asset class. Historically, real estate has provided stable income returns and diversification benefits over the long term, and has also shown robust returns during recovery periods. For example, after the recession in the early 1990s, investors saw a cumulative return of 76% over the next five years.
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In the second quarter of 2024, global real estate values saw a relatively small decline of 0.74%, the lowest quarterly adjustment in the past two years. With offsetting income returns of 1.07%, global real estate achieved a positive 0.33% return – the first positive quarter since 2Q2022. Among the 15 global markets in the MSCI Global Property Index, a slight majority saw write-ups in real estate values for the first time since 2Q2022. Eight markets, including Japan, South Korea, Singapore, Southern Europe, the Nordics, the Netherlands, France and the UK, experienced value increases from the prior quarter. Six markets saw value losses between 0.3% and 1.5%, all of which moderated from 1Q2024. Only Australia recorded a larger write-down in the second quarter than in the first, with a 4.2% correction aligning valuations more closely with its peers. However, changes in capital values are just one component of real estate returns. Historically, the larger component of total returns has been income, underscoring the importance of considering both capital and income aspects when evaluating real estate investments.
In the second quarter, total returns, which combine capital and income returns, were positive in 12 of 15 countries. They were flat in the US (-0.09%), slightly negative in Ireland (-0.22%), and significantly negative in Australia (-3.07%). Preliminary data from the NCREIF ODCE index (a capitalisation-weighted, gross-of-fee, time-weighted return index) showed US total returns turning positive (0.25%). With values beginning to rebound, we expect the positive trajectory in total returns to continue.
Although fundraising for real estate investment is showing signs of a potential rebound globally after two slow years, China and Japan may face challenges. In 3Q2024, China and Japan accounted for 27% and 15% of the US$7.5 billion ($10.04 billion) in cross-border inflows in Asia Pacific. Over half of Japan’s inflows were from global sources, while most of China’s came from within Asia Pacific, particularly Hong Kong and Singapore. Both countries face high debt costs and other factors hindering a strong rebound in real estate capital inflows.
Interest in Chinese real estate from the West has dramatically declined over the past couple of years due to geopolitical and economic concerns. Despite Beijing’s recent major stimulus package, it is unlikely to return soon. The market has been stagnant due to price dislocation, geopolitical risk and lack of liquidity. Since 2021, China has faced a property crisis exacerbated by the collapse of Evergrande. Due to these risks, many European investors are avoiding China and Hong Kong, regardless of potential returns. Additionally, China’s domestic property crisis persists, with high office vacancies and low rental yields, ongoing issues with failing developers, and government interventions.
While major markets like the US have cut interest rates to boost property investment, Japan remains an outlier. The broader Japanese property sector is losing allure due to interest rate policies and limited cap rate compression. In July, the Bank of Japan raised borrowing rates for the first time since 2007 to control inflation, reducing market attractiveness. This hike has prevented cap rate compression, meaning property prices haven’t risen, forcing real estate holders to rely on historically low-income yields. However, senior housing remains an attractive niche due to Japan’s ageing population, with 29% aged 65 or over. These assets are small, requiring an amalgamation play by investors.
Australia’s purpose-built student accommodation (PBSA) market has huge potential due to a significant housing shortage. Only 20% of students in Melbourne and Sydney can be accommodated by universities, forcing the rest to seek private rentals. Additionally, real estate debt in Australia offers appealing risk-adjusted returns. There are funding gaps in construction, with many developers unable to secure bank financing. We are looking at sectors like logistics or PBSA, where we see long-term growth opportunities.
Stabilising valuations and transaction market pricing both suggest that the real estate market is likely near its bottom, but these signals alone do not indicate an attractive entry point. For market pricing and valuations to increase, we would ideally see declining interest rates and strengthening property fundamentals. Most developed market central banks are beginning to taper interest rates, which should put downward pressure on financing rates, discount rates, and property capitalisation rates, thereby boosting the value of real estate assets.
A pullback in construction activity across sectors bodes well for property fundamentals in the medium term. With supply headwinds waning, markets with positive demand due to population growth or structural changes, such as e-commerce, are set to see increased occupancies in the medium term. Historically, occupancies and rent growth are well correlated, providing investors with opportunities to gain from increased occupancies, rents, and the associated rise in property values.
The outlook for global private real estate appears to be improving, but the rising tide is unlikely to lift all boats. For instance, the US office market still faces significant challenges, and a broad recovery in that segment seems highly unlikely in the near term. This underscores the importance of research and selectivity when investing in real estate, as not all markets and property types will perform equally well.
In an uncertain economic and geopolitical environment, additional risks are inevitable, but this applies to all asset classes. Over the past two years, the weight of real estate in investors’ portfolios has significantly decreased due to resetting real estate values and a record stock market. Today, investors might consider fresh allocations to the private real estate market to achieve a strategic weighting. Over the long term, private real estate offers low correlations to other asset classes, strong income returns, and a degree of inflation-hedging. While there may be bumps in the road, we believe the market is beginning to look up, presenting excellent investment opportunities for savvy investors.