- To win, it takes earnings growth and balance sheet discipline
- E-commerce (warehousing) to outpace malls and shopping centres
- Macroeconomic backdrop, monetary relaxation provide support
- Risks include geopolitical tensions, a US election upset and a spike in interest rates
Usually, there are mitigating circumstances when a forecaster explains why their predictions did not materialise. And 2019 was no exception to the rule that a good forecaster is never wrong, but it was the facts that twisted the outcome.
Nonetheless, we did highlight themes that played out and trends that we believe will persist in 2020. Moreover, some of the developments that altered the 2019 narrative will affect market performance again.
Forecasting is the art of saying what will happen, and then explaining why it did not
We had expected Europe to be the best performing region in 2019, with North America the laggard, whereas North American property actually came second behind Europe, while Asia lagged. There were no excuses for the predictions on the rugby field that were wide of the mark: New Zealand and Ireland fell by the wayside along with Wales; hosts Japan did better than its supporters dared hope; South Africa surprised all to win the trophy.
Back in the listed real estate arena, and the US performed as predicted, producing middle-ranking returns, rather like its rugby players in Japan. We had no illusions about the German team, but our hopes for German listed real estate were dashed as Berlin politicians unexpectedly launched rent controls in the capital, causing residential stocks to lag the rest of Europe dramatically.
Exhibit 1: North American property returns came second behind Europe, while Asia lagged - graph shows total returns in 2019 (selected countries; %; in EUR)
Source: FTSE EPRA Nareit Developed index, Bloomberg, 31-12-2019. The value of your investments may fluctuate. Past performance is no guarantee for future returns.
Prediction is very difficult, especially if it's about the future
Nobel physicist Nils Bohr’s sage words came to mind as last year’s unexpected pivot in monetary policy contributed to the strong performance of Real estate investment trusts (REIT) markets, and equity markets generally. The US Federal Reserve led a raft of interest rate cuts. At the end of 2018, such action had looked very unlikely.
A number of last year’s real estate investment themes should persist in 2020. As expected, investors generally rewarded companies that were able to grow earnings accretively. We expect growth to remain a focus, as well as balance sheet discipline.
We also saw REITs with properties in locations marked by considerable demand and supply constraints, such as those along the US west coast, as among the strongest performers. We said the gap between the performance of high and low-quality companies could widen further once investors began to anticipate a market downturn.
We expect the market to reward again companies with well-managed balance sheets and a cost of capital advantage that they put to effective use by growing earnings in an accretive fashion. Secular trends look set to continue, such as investors favouring e-commerce over retail by focusing on warehousing rather than retail malls and shopping centres.
Nonetheless, we believe that investors will focus mainly on company specifics, quality and value. They will largely avoid making significant sector calls.
Compared to 12 months ago, investors are slightly less nervous about the economic outlook. Sino-US trade relations have thawed with both sides appearing to move to end the trade conflict. The basis of the US economy is solid, supported by consumers enjoying rising wages and a robust housing market. There are signs in Europe that the economy, which has slowed substantially, could be about to bottom.
Moreover, most major real estate markets are still experiencing strong tenant demand and generally manageable levels of supply. There is still investor appetite for real estate. We believe hundreds of billions of dollars of private capital is looking for investment opportunities in real assets in 2020.
I never think of the future, it comes soon enough
Predicting the future is not without its risks, as Einstein reminds us. While the trade conflict appears to be deflating, experience warns us to be wary of a fresh spike in geopolitical tension. The renewed conflict between the US and Iran and with it a greater threat to oil supplies reinforces the point that market uncertainty is always close at hand. In addition, a rise in bond yields to uncomfortable levels for markets could lead to a spike in property yields, sapping values. This would harm REITs and real estate operating companies.
As for November’s US elections, investors are focused on a market-friendly outcome, but the programmes of some of President Trump’s potential opponents could prove unfriendly if implemented. Politicians could become emboldened to introduce regulatory measures that would be negative for REITs. Berlin’s rent control caused shares in German residential property owners to plummet and a repeat of similar measures cannot be ruled out.
Ultimately, however, the only certainty about the next 12 months is that at the start of next year, the forecasting industry will be seeking plausible explanations for why our 2020 predictions did not materialise.
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