Defensive Real Estate Areas To Weather A SlowdownDefensiveRealEstateAreasToWeatherASlowdown

GLOOMY OUTLOOK ON EUROPE WITH RECESSION LOOMING

The sharp sell-off in European stock markets this year has opened up historically wide discounts to net asset values, but the outlook for the region’s economy remains highly uncertain. Threats from inflation, extremely volatile energy prices, and potential recession dominate investment markets. Companies with weak balance sheets remain on very significant discounts, as refinancing costs have already increased, and these companies remain exposed to refinancing risk and falling cash flows from further rising debt costs. Cap rates have begun to move up in response to the major upward moves in bond yields, but share prices are implying a much higher move in cap rates to come in private real estate markets. There is a high degree of uncertainty around the future direction of interest rates because inflation has still not been brought under control, and the outlook for demand is weakening as the risk of a recession increases. 

We favor a balanced risk profile to help neutralize negative market impacts as much as possible. More-defensive stocks with lower leverages and higher cash flow yields have relatively outperformed on the whole year to date in the market sell-off. The energy dependency of the European region and of several Continental European economies—notably, Germany—does put them at somewhat greater risk of inflation spikes and energy-supply interruptions from the ongoing war in Ukraine, but the whole region is directly affected. Governments throughout the region and at the European Union level are developing policy responses to the cost-of-energy crisis, which could help offset some of the huge anticipated inflationary shocks. We continue to adopt a cautious stance on the European region and to monitor the rapidly changing situation. 

POCKETS OF OPPORTUNITIES EMERGE DESPITE STAGFLATION FEARS

COVID-19 ushered in a period of unprecedented global monetary easing and fiscal stimulus as countries coped with the economic fallout. Post pandemic, the result has been widespread and sustained inflation on a global scale, exacerbated by China’s zero-COVID policy and the conflict in Ukraine. Equity markets are focused on the pace of Fed hikes and the potential for policy mistakes as stagflation looms. The ongoing conflict in Ukraine poses another threat to global economic recovery, with surging energy prices adding to tail risks on the downside. In the near term, the following themes could be in focus: (1) stagflation concerns, (2) Fed hikes, (3) energy crisis from the conflict in Ukraine, and (4) recovery in reopening names (retail and hospitality).  

We remain positive about Australian logistics, manufactured housing, and self-storage sectors. E-commerce growth and demographic and market consolidation trends provide structural tailwinds for these sectors. The Australian retail sector is also in recovery, as most of the physical-distancing and border restrictions have been lifted. Hong Kong is gradually moving out from the restrictive policies of the COVID era. It could be beneficial to position for reopening of nondiscretionary retail and a potential minimum wage increase in early 2023. In Japan, we prefer companies that exhibit strong shareholder returns and provide greater reopening exposure and favor the heavily discounted hospitality names that benefit from reopening. In Singapore, we like developers in the form of fund manager/landlord plays and prefer diversified office/retail names that are reopening proxies and industrial names with solid rental growth.  

Market concern now centers on stagflation fears emanating from rising Fed rates in a backdrop of recurrent COVID impacts, supply-chain disruption, and an energy crisis from the conflict in Ukraine. Global reopening remains fraught with the risk of subsequent COVID wave impacts amid growing economic and social marginalization. China’s current zero-COVID strategy poses significant risk to the government’s 5.5% GDP growth target. For the rest of Asia, domestic recovery and border reopening are coming up against inflationary pressures. Similarly, a strong recovery in the U.S. could stoke inflationary pressures beyond mere transitory impacts, which could drive expectations of quicker and more interest rate hikes. Supply-chain concerns could hamper growth while creating an inflation spiral that would be harder to arrest. A sharper rise in long-term real interest rates could negatively affect regional REIT valuations. In the event of setbacks on the geopolitical front and potential COVID-19 variants, risk appetite could remain in check heading into the year.