In its latest Quarterly Insights, PGIM Real Estate examines the risks and opportunities across the globe in a slowing economy.
CAUTIOUS OUTLOOK AMID ECONOMIC AND GEOPOLITICAL RISKS
Inflation figures have been on the decline in the region since November 2022, and that trend continued through March, but the level of inflation still remains high throughout Europe. Investors are hoping that the turn in inflation will permit central banks to slow their interest rate increases and end their tightening sooner. However, headline inflation is coming down only slowly, and core inflation is resisting the pressure of higher interest rates. Companies with weak balance sheets remain on near-record discounts to net and gross asset values because they are still exposed to refinancing risk and falling cash flows. Cap rates moved up quickly in the second half of 2022 in response to major upward moves in bond yields last year, but share prices are still implying further moves in private market-cap rates. We remain cautious on the European region in a global context. Our focus remains on companies better equipped to withstand the risk of further corrections as economic and geopolitical risks remain prevalent in the region.
ALL EYES ON CENTRAL BANKS
As global central banks converge on tighter monetary policies in the past 12 months, expectations are solidifying around a mild U.S. recession that would slow further rate-hike momentum. The situation presents an interesting dilemma: where bad macroeconomic news could benefit real estate equities as long as interest rate hikes slow while net operating income is maintained. In Asia Pacific, attention would centre on how the Fed, the Bank of Japan, and the People’s Bank of China move in the coming months.
We remain positive on Australian self-storage and manufactured housing. Demographic and market-consolidation trends provide structural tailwinds to these sectors. As Hong Kong’s reopening is progressing well, the retail and residential sectors are expected to benefit from the reopening. Given rising interest rate pressure, we prefer Japanese developers that exhibit strong shareholder returns with greater reopening exposure. We favour J-REITs in hospitality that benefit from tourism reopening. In Singapore, we prefer the fund manager/landlord plays. For S-REITs, we prefer diversified office/retail REITs that benefit from reopening. We also like industrial names with solid dividend growth underpinned by strong fundamentals.
Market focus is now centering on the depth and scale of a potential U.S. recession as the Fed maintains interest rate hikes aimed at arresting domestic inflationary pressures while at the same time having to handle U.S. regional banking issues. Deglobalisation and geopolitical discords such as the prolongation of the Russia–Ukraine conflict are other factors that continue to warrant concern. In Asia, reopening remains fraught with the risk of subsequent COVID-wave impacts amid growing economic and social marginalisations. How China manages its fiscal and monetary policies to boost its economic growth, as well as its policies in support of its housing market presents uncertainties with regard to the country’s economic outlook. For the rest of Asia, economic growth and monetary policy outlook remain dependent largely on Fed policy and global growth. On the flip side, a resilient U.S. economy could further stoke inflationary pressures and reaccelerate expectations of rate hikes. Within our individual sectors, a sharper rise in long-term real interest rates could negatively affect regional REIT valuations. And in the event of setbacks on the geopolitical front, a potential U.S. recession or potential new COVID-19 variants, risk appetites could remain in check heading into the year.
1. Represents the U.S. portion of the FTSE EPRA NAREIT Developed Index as of December 31, 2022.
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