Real estate - where does relative value stack up?

3 min read 18 Aug 21

In an environment in which investors globally have been forced to take stock, real estate continues to offer attractive relative value, in our view. We believe a pricing opportunity currently exists in the London office market, with real estate Alternatives set to become a bigger part of future portfolios.

Why does real estate stack up?

Prime property yields are still significantly higher than 10-year government bonds with room, we believe, to absorb further increases in fixed income yields. If interest rates do rise, we expect the asset class to remain resilient to potential spikes in inflation owing to the long-term nature of its investment horizon. We believe pension funds are, therefore, likely to continue to turn to real estate in search of income and diversification.

‘Combined with what we believe are bright recovery prospects, in our view London is at a current advantage versus other leading global markets’

How low can yields go?

The longer term question in real estate markets often circles back to how low yields can go. With wide risk premiums, we believe core real estate pricing appears sustainable and offers attractive relative value to investors. Where rental upside exists, yields could push lower still. The pace of compression is, though, likely to slow and will not be even across assets. Not all industrial property will benefit from e-commerce, for example. Caution is needed, in our view, particularly where there may be signs of rapid speculative development. Post-pandemic, we believe quality of cashflow, location and sustainability will become more central than ever before.

Recovery: where are we now?

Consumers are expected to play a key role in driving the economic recovery, since many people have accumulated year-long savings and are eager to spend. However, we expect to see polarisation between different sectors and geographies. Rotating into high growth or resilient industries will, in our view, be key to maintaining portfolio cashflow as we emerge from this pandemic. Yet identifying potential growth tenants may be easier said than done since free stimulus money can sometimes muddy the water. 

Where is the potential pricing opportunity?

Combined with what we believe are bright recovery prospects, London is at a current advantage versus other leading global markets, in our view. Brexit uncertainty has reduced, resolving a major factor that has held back UK real estate pricing in the last few years. We believe investors may be able to capitalise on this pricing differential as it begins to normalise, reinforced by structural strengths such as the London office market’s size and diverse occupier base.

How does UK pricing compare?

Even during the pandemic, core office yields compressed in major German markets, Paris and also Milan – but not in London.

Information is subject to change and is not a guarantee of future results.

What is the direction of travel for real estate portfolios?

We believe real estate Alternatives are set to become a bigger part of future portfolios, with the real estate living sectors offering significant potential. Inadequate housing supply and ‘out of reach’ house prices should continue to drive demand for affordable housing, including private rented accommodation and Shared Ownership, which remains a core political focus. Therefore, portfolios that take account of peoples’ evolving housing needs at each stage of the lifecycle, from student living to retirement, are likely to be best rounded, in our view.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested.

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