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Economics

Outlook 2017: Global cities

Volatility is likely in 2017 in a changing landscape for real estate, but a long-term focus on the strongest companies in the strongest global cities should prove beneficial.

5 December 2016

Hugo Machin

Hugo Machin

Co-Head of Global Real Estate Securities

Tom Walker

Tom Walker

Co-Head of Global Real Estate Securities

  • Volatility likely to be heightened in 2017; there is too much debt and not enough growth
  • The companies we favour are niche operators in strong markets with low balance sheet debt
  • We are excited that select cities are well positioned to forge ahead as the economic powerhouses of the future

The economic and political landscape continues to change, but perhaps not as profoundly as the headlines would lead us to believe.

We were fairly confident that 2016 would be a better year in listed real estate markets based on “lower for longer” in the bond markets. As with any prediction, the best outcome when making one is to be partially right. The markets are up, despite a recent pullback.

The low bond yield environment for the first eight months of the year has been very supportive of global markets. As we move into 2017, we do think volatility will be heightened. The reason is clear – there is too much debt in the system and not enough growth. The key point is that if growth doesn’t materialise, central banks will want to continue to suppress rates.

Seeking the strongest cities

What does this mean for the global cities we invest in? As ever, seeking to invest in the strongest real estate markets can outweigh the scaremongering of newspaper headlines.

We not only look for the strongest cities, but the strongest companies in the strongest sub-markets of those cities. We look for demand trends where new supply cannot impact.

We see many reasons for optimism, on the basis of the markets we invest in, as shown in the 10-year cumulative GDP growth forecasts in the chart below.

We are excited that select cities are well-positioned to forge ahead as the economic powerhouses of the future. These cities have all the ingredients to sustain growth: a broad economy; low supply; good infrastructure; and excellent higher education.

If the global economy turns sour we would remain unruffled and continue to focus on a long-term approach. The short-term noise can be unsettling but it can also provide opportunity.

Niche operators

The companies we favour are niche operators in strong markets with low balance sheet debt. This means the corporate structure is stable and, operationally, the company should have an informational advantage. A business that exhibits these characteristics is in a better position than one that looks to play a rate spread (i.e. simply target assets with the highest yields) to create “value”.

We believe it is important to look at the real estate value chain in a global city. For example, each city is its own economy with interdependent real estate sub-sectors: residential, retail, office, storage, data centres, and industrial. Each sub-sector will mutually benefit from being in that location. We believe companies that know how to exploit this value chain in a favoured location stand to benefit.

The real estate landscape is changing quickly. Customers demand buildings that promote greater idea sharing, retailers provide “just in time” and experiential services, apartment owners provide amenities to occupiers. Companies we invest in are reacting to this demand. It is no longer, as a real estate investor, sufficient to buy a building (on a long lease) using cheap debt and expect a good return. This is because the economic return becomes a function of interest rate movement not asset management.

The road ahead

We look ahead with confidence. Global political and economic issues are inevitable. The stress will be in markets that are less insulated and owning assets that are not actively managed. We do not see much supply in the markets we invest in, nor do we see tenant demand grinding to a halt. Moreover, we are convinced by the draw card of global cities which should ultimately benefit the companies we invest in.

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