Homing in on income growth potential in real estate

Higher bond yields have typically driven real estate repricing in recent months. However, a distinction should be made between pricing changes driven by rising rates and those influenced by changes in projected rental income streams. For example, parts of the logistics market are seeing a marked adjustment in pricing, as low initial income yields contrast with the higher cost of funds. Yet we believe the general outlook for rental income in the sector remains strong, underpinned by the lasting shift towards online shopping and faster order fulfilment. This positive structural trend is likely to support returns from the sector in the medium term, driven by income growth potential.

“Several subsectors reflect long-term structural drivers, supporting occupier demand and cashflows.”

Real estate fundamentals remain attractive

Despite current economic headwinds, occupational markets are likely to remain broadly resilient in our view, owing to relatively low supply of modern assets in European real estate markets. Equally, several subsectors – as in the case of logistics – reflect long-term structural drivers, supporting occupier demand and cashflows. 

The living sectors in particular continue to see a supply and demand imbalance of good quality accommodation in UK and European cities. Providing new, flexible housing solutions can therefore help to meet a structural need, and offer income growth and diversification potential for investors. 

The evolution of working patterns may also position best-in-class office buildings for resilience. Businesses want to attract and retain talent, and buildings that offer an inspiring work environment, with high ESG credentials, are a strong pull. With concentrated occupier and investor demand, these assets can command both green and wellbeing premiums.

Cyclical opportunities may arise

Parts of the market that are more challenged, such as secondary offices or hospitality assets, could offer a cyclical entry point for higher risk/return capital. Upgrading older office buildings to meet modern occupier requirements, or repurposing assets for residential or mixed use, can tap into positive supply and demand drivers. Amid current repricing, investors willing to engage in heavier asset management may be able to acquire assets at attractive pricing and inject capital to create ESG-friendly buildings, which may generate strong potential returns. 

Targeting potential income growth

Irrespective of the market cycle, we believe compelling structural drivers in several parts of the real estate market continue to support income resilience and medium-term growth potential. The ability to buy assets at higher yields and also benefit from potential rental growth could therefore offer an opportunity to enhance risk-adjusted returns. Continued focus on long-term trends as well as individual asset fundamentals and optimum use of capex, remains paramount. 

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. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.