By: Joe Rodriguez, Managing Director and Senior Portfolio Manager, Invesco Real Estate and Andy Rofe, Managing Director, Invesco Real Estate Europe
Many key gateway cities across the globe are seeing structural undersupply of institutional quality real estate, which is making an attractive case for investment.
A global economic environment of below-average gross domestic product (GDP) growth and low inflation potentially offers relatively attractive conditions for real estate.
Capital inflows may capture the characteristics of relatively higher levels of income, capital preservation and growth from investments underpinned by real assets. These flows have been supportive to real estate capital values, with near historically low risk-free rates in many parts of the world offering an attractive spread to real estate investment yields.
In most markets across the globe, supply of new real estate is low and absolute levels of vacancy remain well below historical high points. Construction finance for real estate in much of the developed world remains expensive or is unavailable. The relative lack of new construction in recent years has created more orderly real estate rental markets, which are offering better rental growth prospects when combined with trade, employment or consumption growth.
Many key gateway cities across the globe are seeing structural undersupply of institutional quality real estate, which is making an attractive case for investment. However, real estate fundamentals of both occupier and investment demand remain polarized between good quality assets in prime locations and secondary assets. Lower levels of job creation and reduced consumption growth have reduced overall levels of tenant demand for new space, with demand that exists focused mainly on higher quality assets. Secondary quality assets have been fundamentally weak and we expect them to remain weak for the year.
Increasing risk appetite
We believe real estate investors in Europe may to continue to focus on the stronger economies of Germany, the Nordics, the UK and Poland, and the most liquid markets will continue to be a feature of capital flows. Currently, investors in European real estate remain risk averse, but this may begin to ease in the second half of the year if the greater stability expected by many economic commentators comes to fruition and business and consumer sentiment starts to improve. Some investors are already discussing how, when and where to move up the risk curve and whether pricing on secondary quality assets is now attractive.
Focus on income
We continue to believe that it's possible to take vacancy risk on well-located grade A space and also to consider value-add opportunities that result in "manufacturing" core assets in markets where shortages of prime quality space is emerging. Another trend from 2012 that is expected to continue into 2013 is the focus on income. Since interest rates are likely to remain very low, investors are expected to continue to search for yield, and in this environment we believe the case for real estate may be quite compelling. Understanding local market economic drivers is vital to delivering on asset business plans and real estate performance. Cities with a strong global reach like London or a dynamic export-focused industry like Munich may potentially benefit from the gradual economic recovery forecast outside Europe in 2013.
Continued global urbanization
The diversified global investment universe offered by real estate securities also continues to seek attractive opportunities from both an income and capital growth perspective. Listed real estate equities -- mainly real-estate investment trusts (REITs) -- may offer exposure to the on-going global urbanization trend, in particular in many emerging world geographies where the scale of activity is still large. In addition, they provide exposure to real estate sectors with high barriers to entry that may be experiencing significant demographic, wealth distribution and technological changes. Examples include health care, apartments, prime malls and data centers -- all of which are experiencing positive fundamental performance trends. In our opinion, many REITs now have strong balance sheets and are able to access multiple sources of investment capital. Earnings growth prospects for 2013 are expected to remain positive, with companies able to generate growth from a combination of lower financing costs, internal rental growth, accretive acquisitions and development activity.
Listed real estate equities may offer opportunities for exposure to the on-going global urbanization trend.
Attractive risk-adjusted returns
We believe real estate fixed-income focused investments, such as commercial mortgage-backed securities (CMBS) and REIT preferred shares are offering attractive risk-adjusted return characteristics, along with access to higher levels of income backed by commercial real estate. Interest in balanced real estate securities that invest in both equity (REIT) and fixed-income real estate investments and offer a higher, stable and growing income yield, with lower price volatility and daily liquidity is increasing. Real estate securities valuations across all investment types currently appear fair by longer-term standards, given a relatively attractive yield and the continued prospect of earnings growth in a world still short of both types of characteristics.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
Risks of collateralized loan obligations include the possibility that distributions from collateral securities will not be adequate to make interest or other payments, the quality of the collateral may decline in value or default, the collateralized loan obligations may be subordinate to other classes, values may be volatile, and disputes with the issuer may produce unexpected investment results.
Mortgage- and asset-backed securities are subject to prepayment or call risk, which is the risk that the borrower’s payments may be received earlier or later than expected due to changes in prepayment rates on underlying loans. Securities may be prepaid at a price less than the original purchase value.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.