PGIM Real Estate, the global investment arm of Prudential Financial Inc., which has $69.6 billion assets under management across the U.S., Europe and the Asia Pacific region, released its third annual global outlook report this week. The key message of the report: commercial real estate is still a strong sector, but the uncertain length of this cycle has investors questioning what do to next. NREI breaks down a few of the report’s findings, along with comments made during a web presentation of the report by two PGIM executives.
- Investors may be nervous, but there are reasons for positivity. In general, cap rates are stable, though there are some exceptions, said Eric Adler, CEO of PGIM Real Estate. This is leading to nervousness on the part of investors. “They do feel that we’re later in the cycle. We’re at values that are close to all-time highs,” he said. However, the underlying supply-demand dynamics for the most part remain stable, as supply had been subdued this cycle because of regulatory changes after the financial crisis. On the demand side, there has been consistency and a lengthening of the real estate cycle and there have been no financial excesses of the kind that led to the previous financial crisis, Adler added. “There is a decent amount of demand and it keeps on growing,” he said.
- Returns are strong, but moving lower. In the U.S., the firm estimates 10.7 annual returns on commercial real estate investments, compared to 9.3 percent in Asia and 13.7 percent in Europe, according to the report. Investors are thinking more about pricing and returns given the length of the cycle, said Peter Hayes, head of investment research at PGIM Real Estate. “This is a long cycle and we can’t predict when this cycle will end, but we do know that investors are thinking more and more about the returns outlook, interest rates,” Hayes said. There is also a lower long-term returns outlook—a topic of discussion for the past two or three years, Hayes said. Based on current interest rates, the firm projects that from 2018 through 2028, unlevered global all-property prime markets will see returns of 4.8 percent. The figure was 10.2 percent for the period from 2011 to 2017. The lower forecasted return is a result of low yields, low inflation, weak productivity growth and some oversupply. Last year, yields declined across most major sectors around the world, the report noted.
- Diversification is key. By looking at how markets perform over time relative to each other, diversification across regions and sectors is a necessary strategy, Hayes said. The firm analyzed the returns for sectors and regions around the world, ranking from highest to lowest performing from 1995 to 2017; it is unclear which sector or region (office, industrial, multifamily and retail in the U.S., Europe and Asia Pacific) is a standout for performance over the long term. “There’s no obvious pattern over which sector, which region performs the best relative to all others,” Hayes said. According to the chart, the U.S. industrial sector has performed the best in 2017, with 23 percent returns, and the U.S. retail sector the worst—with 3 percent returns. There is also a case to be made for diversifying the capital structure as well, Hayes added.
- Gateway markets will likely remain attractive for investors. Gateway markets have long been attractive to investors, but low yields, a slowdown of yield impact and moderating rents have signaled that gateway markets have been underperforming a wider index of global all-property returns, the firm found in its report. A sample of 13 markets showed an average prime net initial yield of just 3.7 percent. Still, caution after the financial crisis continued to draw investors to these big markets, though there has been somewhat of a shift toward 40 “other major cities,” which in the U.S. includes places like Nashville, Tenn., Portland, Ore. and Philadelphia that have all seen increased transaction volumes. Still, the report concludes that gateway markets will be top of mind for investors; they have the scale and liquidity many are looking for, as well as institutional participation. And in the long run, gateway markets perform better.
- Investor appetite in the U.S. is increasingly selective. There is still a lot of capital flowing into U.S. real estate, the report notes, but the picture changes when looking at individual property types. For example, sales of industrial properties grew by 24 percent over the last year; retail property sales plummeted by 24 percent. Tertiary markets are gaining attention in the multifamily space, and high-yielding suburban office properties have held up as well. Sales of office properties in the central business districts have fallen by 25 percent over the past 12 months, but the report notes this is a result of a slowdown in activity in lower-yielding markets like Manhattan.
- In the U.S., investment opportunities lie in suburban apartments, niche sectors and the logistics space. Class-B suburban multifamily assets are set for growth, particularly if they have good access to public transit and walkable amenities, the report stated. There has also been increased investor interest in non-traditional property types—thanks to a search for higher yields—and the changing behavior of consumers continues to fuel the demand for more logistics assets, the report found.
This article provided by NewsEdge.