Total Property - Issue 6 2019
In its latest Active Capital report, Bayleys’ global partner Knight Frank identifies the approach of an inevitable end to a longer-than-normal economic cycle as one of the key themes that will shape the next phase of real estate investment.
As with much of the industrialised world, the low-interest-rate environment post the global financial crisis (GFC) looks set to remain in play for an extended period in New Zealand, and the demand for higher-yielding assets is extending the property cycle.
While this prolonged cycle has been rewarding for many investors in commercial and industrial real estate, the report’s authors warn against unrealistic expectations for late-cycle returns, and flag the need to re-think investment strategies.
New Zealand is now into its ninth year of growth following the GFC. The researchers note that, at more than nine years, the current US economic cycle is double the average length of the previous 33 cycles. The UK is also nine years into its recovery while, for our Australian neighbours, the run of national GDP growth has extended for 27 years, a record among developed economies.
Andew Sim, Knight Frank’s head of capital markets, points out that just a year ago, the investment community was gearing up for higher interest rates and even recession.
“After all, the cycle was nearing maturity. Today, we find ourselves in a different scenario as dovish central banks rein in their ambitions for rate rises and economic growth expectations start to ease, yet capital remains as abundant as ever.
“In this world, the attractions of real estate yield remain compelling, but investors must adopt strategies that reflect this extension to the cycle.”
William Matthews, Knight Frank’s global head of capital markets research, says commercial real estate has a strong story at this late stage in the cycle, with many investors seeing it as an attractive way to diversify outside equities and bonds. It provides the relative stability that equities are lacking and the income that low-yielding bonds are increasingly missing, he says.
“However, within commercial real estate there is temptation among some investors to move up the risk curve to maintain returns in this lower-growth environment. Investors across the risk spectrum should not lose sight of their risk exposures and consider looking for return more defensively.”
The key challenge in such a late-cycle environment, according to Matthews, is to find acceptable return “without the same proportional increase in risk”.
While some investors will seek opportunities by looking at big-picture structural, demographic and technological shifts, the economic story is increasingly stronger at a local rather than country level due to urbanisation, says Matthews.
“It is important to look at the specific demographic trends of an area, to target the right city and the right assets for that city.”
This approach should also encourage investors to explore specialist commercial property sectors, such as senior living and healthcare where populations are aging, or the private rented sector where growth is coming from a younger population.
“The caveat is that accessing returns in these sectors often requires exposure to operational businesses and greater reputational risks, which may be unpalatable or even structurally impossible for some investors,” says Matthews.
The researchers also expect investors to target economies and sectors less prone to volatility, which bodes well for New Zealand’s ability to attract offshore capital given the relative stability and “safe-haven” status of the market.
CBD locations within gateway cities such as Auckland remain the favoured investment destinations. But, with assets in prime locations tightly-held, the search is now extended to city-fringe and suburban locations as capital follows tenant movements out of the city centre.
Interest in these areas is increasingly bolstered as blue-chip tenants, particularly those from the IT and utility industries, choose to base their head offices in amenity-rich areas. Recent examples in Auckland include Xero moving to Parnell, Mercury Energy to Newmarket, Watercare to Remuera and Genesis Energy to Ellerslie.
The report notes that, having identified target locations, some investors will seek higher returns through reinvention and redevelopment. But they urge investors to keep expectations realistic.
“The current environment is undoubtedly beneficial for commercial real estate,” explains Matthews.
“For investors, the danger is that expectations remain anchored in the days of higher returns, leading to the chasing of unrealistic performance at the cost of elevated levels of risk.
“However, for those undertaking appropriate strategies, we believe the cycle will continue to deliver.”
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