A Promising Entry Point into Global Real Estate

Within the core (low-risk) space, we continue to observe high occupancy rates, long weighted average unexpired lease terms, and low loan-to-value ratios. The attractive valuations, married with strong fundamentals, present a compelling opportunity for investors seeking to enter a new real estate cycle.

Increased interest rates resulted in a spike in the cost of capital and engendered negative leverage (where financing rates exceed property yields), driving the repricing. Transaction levels have significantly dampened, and a mismatch between buyers’ and sellers’ pricing expectations persists. Yield expansion has occurred for a year, and the markets are still in the process of discovering appropriate pricing. We have observed substantial progression in the contraction of headline inflation, yet core inflation remains sticky. Tackling core inflation will remain a top priority for central banks. The prevailing sentiment is that most central banks may conduct one more small interest rate hike this year, with a potential first cut occurring in the first half of next year in the US. If this unfolds as forecasted, we should see renewed optimism flow back into the real estate markets.

The yield expansion movement has varied by sector and market. Looking at the three core regions, the APAC region has demonstrated the most resilience (with the exception of Australia), thanks to a better-insulated office market and lower inflation levels. The US and European markets have now recorded four consecutive quarters of capital depreciation, resulting in a substantial correction.

Considering the sectors, the traditional office sector has been impacted most, particularly in the US, due to reduced tenant demand resulting from the prevalence of home office. The picture is different in Europe and the APAC region, where prime offices are proving more robust. The logistics sectors in Europe and the US underwent significant repricing due their low yields, yet they remain underpinned by rental growth and healthy tenant demand. The residential sector has experienced strong rental growth, driven by low affordability for house purchases and supply/demand imbalances. Supply has, however, increased in some markets in the US recently. Sentiment for retail is mainly negative due to the forecasted growth in e-commerce and lower consumer demand. However, it has experienced less yield expansion as yields were already relatively high. Over the past year, the alternative subsectors, namely student and senior housing, medical office, life sciences, and self-storage, have delivered most protection during the downturn, reinforced by strong leasing and their non-cyclical nature.

Due to recent depreciation, real estate yields in some markets abroad have reached their highest levels in over a decade. Interest rates are expected to stabilize this year and then decline next year. Real estate yields are forecasted to follow this trajectory. Thus, we expect to see yields to settle later this year and compression to transpire next year. Rental growth and solid fundamentals in select sectors should further boost performance. Four straight quarters of depreciation have pushed most portfolio yields north of 5% across the US, Europe, and APAC region. These levels look particularly appealing when compared to those in the Swiss market, which have not experienced a similar degree of correction. The current opportunity in real estate abroad is especially interesting for investors looking to capitalize on attractive pricing, enhance diversification, and access alternative sectors that have not yet become domestically institutionalized.