Global Real Estate Securities Commentary 4Q 2021GlobalRealEstateSecuritiesCommentary4Q2021

Global Market Review

Real estate's recovery may transform into a robust expansion in 2022 because of above-average demand. Cities are seeing signs of improved rental growth, with central business districts and centrally located apartments benefiting from a sharp increase in hiring. Net operating income for retailers is rising as consumers increase spending. Supply growth is set to increase in coming years, although it may trail historical averages. Although the wide gap between the best- and worst-performing segments of the real estate market may persist, the differences are starting to narrow, and location likely will drive the industry's performance once again. Elevated rates of inflation will likely be additional tailwinds for the sector, so REITs may serve as attractive inflation hedges. 

The COVID-19 pandemic severely challenged the global real estate industry during the past year. First, it virtually shut down office culture, socialization, and travel. Then, as the world recovered, global real estate transformed. With different parts of the world experiencing their individual stages of recovery, three distinct trends are driving compelling opportunities for real estate investors: reopening, reflation and recalibration. Those trends are creating tactical opportunities for short-term gains from mispricings or reversion to the mean, as well as longer-duration opportunities from the recalibration of real estate supply to evolving demand. 

Economies have been gradually reopening around the world, although the progress is far from uniform or linear. Virus variants are driving fits and starts in the reopening process, leading to tactical opportunities. The recovery in North America, 2021’s best-performing region, is six to nine months ahead of Europe’s and Asia’s, which is creating short-term opportunities in those regions, with their hard-hit sectors expected to recover in the coming year. The reopening of economies is expected to release pent-up demand in various consumer industries, including travel and lodging. Because COVID-19 vaccinations are progressing at varying speeds around the world, this trend will likely continue for months, if not years. 

Restrictions on mobility together with the shutdown of experiential businesses hurt urban real estate disproportionately. With restrictions easing in major cities globally, we anticipate sharp rebounds in leasing volumes for urban multifamily assets and retail assets that likely will benefit from the return of local residents who left cities during the pandemic. 

Office space is beginning to see rent growth, but valuations remain low. Large capital expenditures to modernize buildings and meet environmental, social and governance requirements will pressure operating income and revenue. The older-adult housing market is recovering rapidly, as many who deferred moving into such facilities are now selling their homes (given the rise in house prices) and shifting to older-adult housing developments. 

Real estate tends to outperform broader equity markets during periods of moderate (2.5–3%) and higher (3–4%) inflation. Historically, real estate has demonstrated strong correlation with inflation, particularly in assets with short-lease durations and strong operating leverages. Shorter-lease-duration assets tend to appreciate the most when reflation takes hold, particularly those seeing strong demand, because it enables lease holders to pass expenses along to their tenants. Residential properties offer inflation protection. These asset classes are poised to benefit from reflation, as improving cost controls and supply/demand imbalances should lead to above-consumer-price-index operating-income growth. U.S. multifamily housing is an attractive area, as it is experiencing a surge in investment activity from private real estate sources. Annual lease durations, together with rising cost controls and technological innovation, make the asset class a strong inflation beneficiary. Replacement-cost increases are leading directly to accelerating market rent growth. Coastal multifamily properties should particularly benefit from a recovery, as occupancy levels rise after reduced move-in activity during the pandemic. 

Technology is profoundly altering the global need for real estate and informing where demand will come from over the long term. Technology has also enabled some REITs to take advantage of their scale and operating histories to incorporate vast volumes of data into various aspects of their businesses. What will follow is a period of consolidation, as some REITs acquire small- to midsize trusts to realize value through efficiency gains. Real estate is also conforming to new regulations and tenant demand for more environmentally friendly or even net zero properties.