Alexa, what will happen to real estate if there is a recession?

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Virtual assistants such as Alexa are the font of all knowledge (to some), but when it comes to the all too real anxiety about the health of the global economy, and by extension, the shape of global listed real estate, investors are desperately reading the tea leaves – in the form of the latest data, anecdotes and presidential tweets – for meaningful signs of what actually lies ahead.

  • Listed real estate is benefiting from strong demand by corporate tenants and investors
  • Substantial sums are waiting in the wings
  • Falling bond yields should support the listed real estate market
  • The risks are not much different from the current equity market threats

The recent fortunes of the stock market have been more correlated with the early morning transatlantic Twitter stream than with underlying economic developments. But in less tendentious times, equity market movements have been viewed as a – crude – leading indicator for the broader economy, particularly in the US. In a similar vein, and with similar disclaimers, analysts have used listed real estate indices in the larger markets as a broad barometer of the health of the direct real estate market.

Exhibit 1: Global real estate – a guide to equities and the wider outlook (total returns, EUR;  August 2018 = 100)

Exhibit 1: Global real estate – a guide to equities and the wider outlook (total returns, EUR; August 2018 = 100)

Note: FTSE EPRA NAREIT Global Developed index (EUR), MSCI World Developed index (EUR); Bloomberg; 27/08/2019. The value of your investments may fluctuate. Past performance is no guarantee for future returns.

Both global equities and global real estate have fluctuated as market concerns over recession in Europe and the US and the ability of central banks to step in waxed and waned (see Exhibit 1). The summer months have brought considerable uncertainty and markets became more volatile, raising the question of whether markets were now signalling impending recession or a more nuanced outlook. Certainly, risks of a downturn have risen in recent months as Exhibit 2 confirms, with more market participants expecting a US recession in 2020.

Exhibit 2: Recession – it has become more probable

Exhibit 2: Recession – it has become more probableSource: Bloomberg; 28/08/2019

Real estate stocks joined the rally in global equities in the first quarter of 2019, particularly as concerns over interest-rate increases eased off. However, since the summer nights started to give way to the first signs of autumnal evening chill, and as stock markets came off their recent highs, global real estate investment trusts (REITs) have held up better than equities generally. Returns have on average exceed those on equities by around 6% since the end of July.

Do not decouple the global listed real estate outlook from the economy at large

It would be extremely over-simplistic to suggest that real estate equity markets are indicating a less onerous outlook for the direct real estate market than for the wider economy. However, direct real estate market forecasts from agents such as Jones Lang LaSalle (JLL) predict that despite the current global macroeconomic challenges, direct real estate markets are still benefiting from strong demand from corporate tenants and investors alike.

Indeed, rental growth has been at around a solid 3.5% so far this year, according to JLL data from the end of June 2019. This is expected to slow to around 3% by the end of 2019 before easing back to around 2.5% in 2020.

In addition, the capital that investors have for investing in physical real estate remains high. JLL expects more than USD 600 billion to be invested in 2019 globally, down slightly on 2018’s record. It does not expect any significant drop-off in investor demand in 2020.

Exhibit 3: Strength in investment in global direct real estate and prime office rental growth

Exhibit 3: Strength in investment in global direct real estate and prime office rental growth

Exhibit 3: Strength in investment in global direct real estate and prime office rental growth

Source: JLL; 30/062019. The value of your investments may fluctuate. Past performance is no guarantee for future returns. As a result of currency fluctuations, returns can increase or decrease.

Capital could flow to real estate as uncertain outlook favours havens

Listed real estate has lost some momentum since the middle of the summer. However,  developments in the wider economy, and especially the bond market where yields have fallen sharply, support the significant interest in both the private real estate markets and increasingly in the public markets. With many asset allocators currently underweight real estate equities in developed markets, particularly in the US, capital is likely to start flowing into listed real estate if bond yields remain at today’s extremely low levels amid elevated macro-political risk.

Weaker investment and leasing activity compared to 2018 point to a slowdown. However, given the still strong tenant interest and the substantial sums expected to be invested over the next six to 12 months, there is room for upside. With USD 324 billion of unspent capital targeting US private real estate, according to August data from Preqin, listed real estate pricing could see a fillip.

Our virtual assistants may well inform us reassuringly that as with the equity market, the listed real estate market faces further volatility, even given its relatively benign outlook. The issues around trade policy and European politics and the growing threat of a US recession remain substantive risks to both markets.


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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

 

Shaun Stevens

Real Estate Strategist

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