State of Real Estate Markets in 2018: A Western Tale

In the books and journals chronicling the annals of finance, one name is often relegated to the footnotes of history, if not left out altogether. The late English mathematician and physician, Sir Isaac Newton, who was born just years after the crash of the Dutch Tulip Bubble, one of the most famous market bubbles in history that collapsed in 1637. The laws of gravity as propounded by Newton in its simplest form, could be interpreted as: what goes up, comes down. Because, gravity. Now take that and apply it to finance and one can expound upon everything from stock prices to booms and busts in the markets – what goes up, comes down. Perhaps it was simply a coincidence that Newton himself would go on to lose £20,000 when the South Sea Bubble went bust. It is against this context and maxim that this report looks at the trends and patterns in the real estate sector in the coming year, to see where the ups and downs are, and if at all, any boom is to be seen or a bubble about to bust.

United States:  Trump, Tax Reforms, Millennials and Housing Growth

It’s been almost close to a decade since the global financial crisis fuelled by the mortgage backed securities battered the housing and real estate markets in the US to its lows. 2017 was a landmark year in the markets after the crisis as they managed to reach new peaks around the world. Strong market fundamentals and positive sentiment among investors have prevented any slowdown in the global markets, which has cascaded over to the real estate sector as well. As organic growth continues to fuel the economy in the United States, the fundamentals remain positive, despite the numerous political issues plaguing the Trump presidency.

As the markets move along on an upward tick, fears arise that it might go bust again like in 2007. However, it is to be noted that it was mainly the sub-prime and poorly documented mortgages combined with heavy market speculation that caused the last crisis. The Dodd-Frank Act passed in the aftermath of the last crisis tightened lending standards in the markets, leading to a median home loan FICO of 734 in 2017 compared to about 700 back in 2006.

With the tax stimulus package that was passed last year, growth in the US is expected to hit a three year high of up to 2.7% in 2018. After years of having maintained low interest rates in the economy considering the volatile conditions in the global markets, the Fed is expected to increase short-to-medium term interest rates. The spill over effects of increased mortgage rates as a result could negatively impact the real estate investments and thereby slow down the growth. The slower rate of expected GDP growth could also likely hurt the transaction volumes in commercial real estate activity.

With the overall economy on a strong growth momentum, the real estate market is expected to move upwards in 2018 as well. Having completed almost a year in office, Trump looks set on bringing in the long-awaited infrastructure legislation bills, a campaign agenda on which he rode his way into the White House. As major agreements seem to be close to being renegotiated to revamp the defunct roads, bridges and other infrastructure in the country, the sector is expected to pick up pace as the demand for raw materials will go up along with the requirement of places to store them.

Also, as the construction industry enters into a bull phase of the cycle, the supply of new homes into the market will ease the pressure on the rising demand for them.  Another sector that will be driving the growth this year will be e-commerce, as companies continue to expand their market and increase the leasing demand for distribution centres that are required to meet the ever-growing rapid delivery demands of their customers. By increasing their investment in last mile storage and distribution spaces, the e-commerce firms have shifted their location strategy to an increased focus on closeness to customers and labour.

With the rising inventory in the housing sector, the YoY housing growth is expected to be positive in 2018. Millennials will be gaining market share across the price segments and could make up to as much as 43% of all the new buyers this year, with many of them being first time buyers. This would lead to price appreciation in entry-level homes as the demand in this segment far exceeds the supply.

Other factors in the market— like increasing urban growth, the rising longevity of baby boomers and a host of macroeconomic and regulatory developments— make it an exciting time to be following and timing the investments in the US real estate markets this year.

Europe: Brexit, Low Interest Rates, 3 Strong Years of Growth

Despite the political turmoil and the rise of populism throughout the course of national elections in major European economies over the last two years, most of the countries within Europe finished the past year on a strong note and high investor confidence in the markets. Unless there is a major shock event that disrupts the markets entirely, this growth can be expected to continue in 2018 and next year as well.

The GDP for the Euro area rose by 2.7% YoY in Q4 2017 – well above the average– and unemployment stood at 8.9%, almost a full percentage point down from the last year. In GDP growth terms, recovery was led by Central Europe, Sweden, Netherlands, Spain and Ireland. The ECB, is still on its long journey of ending quantitative easing and returning to its business-as-usual monetary policy. Given the loose monetary conditions in the market, investment volumes in real estate will grow further as the sector continues to be relatively attractive compared to other asset classes. However, by early 2019, the ECB is likely to begin hiking interest rates from their current unprecedentedly low levels.

In the real estate market itself, there are three major noticeable trends that will influence the markets over the course of this year. Firstly, rental growth is expected to continue. Considering the supply-demand equation once again, given the current scarcity of supply, the amount of empty space in the sector is down to levels seen before the crisis. As such, the rising demand will boost the rental growth in the markets in 2018 and beyond.

The year could also turn out to be the last year of strong low interest-rate-driven returns in the European real estate market. Investors would be better off staying away from properties exposed to income risk and making limited use of leverage for investments. The decline of capital returns and rise in the cost of borrowing will reduce returns on investment over the medium term this year.

Lastly, the retail and industrial sectors will be outperforming the office sector in 2018. Improvements in the manufacturing industry, along with the growth of e-commerce, have resulted in solid and sustainable occupier demand for good-quality logistics space, and the sector offers relatively high yields. However, even after accounting for the aforementioned trends, several risks exist. They arise from a sharp rise in bond yields and rapid expansion of supply. The bond yield spike would make real estate less attractive and drive investors to other asset classes while the surplus supply would negatively impact rental growth.

As far as geopolitical scenarios are concerned, even after Brexit initially rattled the markets, London still retains its top place and is seen as a safe haven for investors to park their funds in. The investment activity volume and level of interest from investors in China and Hong Kong has increased after the Brexit vote. In the U.K. itself, the investment activity in the first half of 2017 rose by 18% to its third-highest level on record in local currency terms, as per reported by JLL.

The combined factors of increased economic confidence, easing political tensions and rising capital inflows into the markets has brightened the outlook for European real estate. European investment volumes in the first half of 2017 stood at $114 billion, up 7 percent from the $106 billion in the same period of 2016.

Within continental Europe, the country that seems to have benefited the most from Brexit is undoubtedly Germany. Germany remains the top go-to destination for many looking to invest in Europe. The investment volumes in Germany stood at $56.89 billion in 2017, a 7 percent gain from $52.9 billion in 2016. Also, some of the most stable global investments are in Germany. With a growing trend of supply-demand imbalance in the markets, despite the strong market regulations on rent, a growth in rental rates is starting to emerge.

Even Spain, with its liquid capital markets, has started recording strong growth, with investment volumes reaching close to 10.3 billion USD in the first three quarters of 2017, a 74 percent growth over the previous year. However, much of the growth to come this year depends on how well the politically-volatile Catalonia crisis plays out in the region. Apart from Spain, sentiments among investors are high across Netherlands, France, Denmark, Sweden and even as far as Poland over the potential benefits stemming from Brexit. Currently established as the most developed market in the whole of Central and Eastern Europe and having the largest stock exchange, Poland is expected to bring in a REIT legislation later this year. This will only add to more liquidity, transparency and investment activity in the country.

To summarize, Europe will continue to experience about three more years of growth, all the way until early 2020. As the US long-term interest rates rise over next two years, European rates will also increase, causing the brief slowdown in the sector. The higher long-term interest rates will negatively affect the pricing in the real estate sector but should subside by 2020. As for Brexit, the UK markets will see a brief period of uncertainty, but the market fundamentals remain strong, and the overall volumes will experience a strong uptick from the year 2021.

All in all, were he still alive, Sir Newton would have been better off in investing his £20,000 in the American and European real estate markets in 2018. There seem to be no imminent bubbles on the horizon anywhere. Except Bitcoin, but that’s another tale for another day.

Sources: CBRE Research, Colliers, Cushman Wakefield, European Central Bank, Jones Long LaSalle, Knight & Frank, PwC, Statista, US Fed, Urban Land Institute

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