The further loosening of monetary policy in Asia and Europe points to continuing good returns from commercial property, writes TH Real Estate’s Alice Breheny.
The last few years have been kind to investors in commercial real estate in many developed countries around the world.
One indication of this is rising transaction volumes.
In the United States, for instance, transactions grew from US$246 billion in 2012 to US$305 billion in 2013 to US$353 billion in 2014. In the United Kingdom, the figures were US$55 billion, US$78 billion and US$90 billion.
Another pointer has been rental yields from commercial real estate.
These have continued to fall. In some markets, the valuation metrics have returned to near the levels that were prevailing prior to the global financial crisis.
Widely used measures of returns indicate that investors in commercial property and the United Kingdom earned returns of around 12 per cent and 18 per cent last year.
These two countries account for about half of the universe of investible commercial real estate globally. Investment has also been picking up in a number of centres in continental Europe and, of course, in Australia.
In assessing the prospects for national markets, TH Real Estate looks at five factors: monetary (M) policy; aging and demographics (A); government policy (G); innovation (I); and entrepreneurship and competitiveness (C) – or MAGIC for short.
What really matters is that almost all of the countries that we consider are characterised by expansionary monetary and government policies.
In terms of monetary policy, we think that the United States, the United Kingdom, Canada, Poland, Japan, Singapore and Hong Kong are at a fairly late stage of monetary expansion (which is usually very positive for commercial real estate).
Australia and the euro area are, we think, at an early stage (or positive). We assess monetary policy in China to be broadly neutral.
Government policies are early in the expansionary phase, or neutral, in most of the countries that we consider.
In practice, this means that economic growth should be fairly strong in much of the world (if moderating in some countries) over the course of 2015.
Consensus forecasts are for 4.7 per cent growth in the Asia Pacific, 3.2 per cent in the United States, 2.6 per cent in the United Kingdom and 1.1 per cent in the euro area.
The other three key factors – aging and demographics, innovation and entrepreneurship, and competitiveness – generally do not change much from year to year.
Ageing and demographics is a negative factor in much of the euro area and Japan, however it is very positive in the United Kingdom, Australia (thanks to immigration), Singapore, Sweden and China.
We assess innovation and entrepreneurship to be negative in Spain and Italy, but otherwise neutral to positive. The same is broadly true of competitiveness.
Picking the attractive markets
A separate question is how we determine the countries we should research and in which we might make investments.
In general, we look for four things: solid rule of law; low sovereign risk; high real estate market transparency; and ample liquidity in the commercial real estate market.
We will also consider countries that are slightly deficient in these respects, provided we can identify specific opportunities.
At the moment, Poland is a good example. Poland has a pro-western and stable government and a solid banking sector.
Like Australia, it was one of the few countries that avoided recession in the global financial crisis. Moreover, with official interest rates at two per cent, the central bank has room to manoeuvre.
In short, it is useful to take a flexible and granular approach to researching opportunities in commercial real estate markets globally.
As ever, details vary from country to country and from city to city. In some cases, monetary conditions have changed quite a lot over the last year: the European Central Bank adopting quantitative easing and the US Federal Reserve ending the asset purchase program are cases in point.
Overall though, all the national markets that we monitor remain in the early expansion or the late expansion phases of their property cycles. That suggests to us that there are still good opportunities for investors.
Focus on cities
Having identified attractive countries, investors need to consider what are the cities that are likely to be the most rewarding.
Given the dynamics of supply and demand in each city, the prospects for commercial real estate can be a little different to what they are in a country as a whole.
As of May 2015, we see Paris, Madrid, Barcelona, Milan and Sydney as being at a late expansionary stage of their respective property cycles, while France, Spain, Italy and Australia are all at early expansionary stage.
Conversely, many of the second-tier cities in Germany, the United Kingdom, the United States and Asia look to be at an early expansionary stage: this is in spite of our view that the countries are all at a late expansionary stage.
Of the MAGIC factors, it is possible to use all bar monetary policy to evaluate individual cities. National government policies usually apply to entire countries.
However, for particular cities, local government policies can also have a big impact on the prospects for commercial real estate.
Ageing and demographics can also differentiate cities.
The inability to attract a younger working-age population reduces both the vibrancy of a city and its tax base.
Innovation and entrepreneurship, along with competitiveness, also generate employment and attract businesses.
Alice Breheny is the global co-head of research at TH Real Estate, London.
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