Growing confidence

The following is an extract from our 2025 global outlook.

Lower policy and market interest rates over 2024 had helped real estate yields stabilise, with tightening in some cases. We think uncertainty regarding the future path of rates weakens conviction for meaningful real estate yield compression next year.

This has already been broadly anticipated in many forecasts, however. In the UK, PMA predicts a modest -20 bps over 2025-2029[1] while in the US, Green Street eschews yield forecasting and places its emphasis on operational income growth. This allies with our view on markets: Real estate returns are expected to be reasonable, based on yields that have already reset and subsequent income growth – not yield compression.

In our view, market pricing and valuation, which bifurcated in 2022, now appear closer, suggesting most of the correction has now happened and that there is greater confidence in fund and asset valuations. Valuation yields also look very close to where our models suggest ‘they should be’, albeit with the UK marginally ahead of the US and Europe.

The risks to such models are market interest rates settling higher for the near–to-medium term (i.e., ignoring current volatility) with income growth insufficient to compensate.

Although economic growth is unexciting, it is not recessionary. The UK’s budget was deemed to have a broadly neutral effect on growth expectations. As Tim notes, Trump’s re-election is broadly seen as pro (nominal) growth, albeit more inflationary. The situation in Europe is more sluggish, although recent readings beat expectations. We therefore expect modest income growth. PMA, for instance, forecasts 2.4% annually for Europe and 2.7% per annum for the US over the 2025-2029 period for prime real estate.

Our sector views

Identifying the locational and sectoral tilts to beat these averages is, of course, key. The market consensus remains broadly focused on living and industrial sectors, which is understandable given compelling structural tailwinds. We believe selectivity is critical for relative performance, preferring multi-let and urban logistics relative to regional logistics and a very geographically targeted residential allocation across specific tenures.

We acknowledge slowing performance in industrial leasing but see this as a temporary pause after exuberant take-up during the pandemic. We are broadly more cautious on retail than the consensus, with less bullish views on the consumer. We are, however, aligned with strategies around repriced assets in suitable lot sizes. Offices remain difficult – on average – but extensive repricing creates opportunity for resilient assets in specific locations. It is difficult, however, to see investors taking binary locational risk in this sector; this could become a crowded trade.

Investment volumes remain low, with global capital historically hesitant. This is inconsistent, we think, with our more positive narrative for sector performance. We reason it reflects the slow journey between positive pricing signals to fund raising strategy to deal execution. We expect 2025 to be a much stronger year for asset performance and market liquidity.

The above is an extract from our 2025 global outlook. 

[1] Source: Property Market Analysis, as at September 2024.