In its latest report titled, “2019 Global Alternatives Outlook [1],” JP Morgan Chase [2]sheds light on global trends and opportunities in the real estate industry.
The report indicated that several investors in the U.S. real estate market have “tilted their new allocations to value-added properties in the search for higher returns, reaching an inflection point.” The key driver of this shift is a considerable increase in construction costs for property improvement or development that is thinning the return premiums for construction risk—leading to a limited supply of new core properties. This has allowed some stabilized, fully leased core properties to sell below the now elevated cost of building new unleased assets, the report stated.
According to the report, since early 2016, the income from leases of existing U.S. core assets has been growing at a faster annual rate (4 percent to 5 percent ) than core property values (2 percent to 3 percent), since early 2016. JP Morgan Chase anticipates the rising construction costs to help support the increase in rental incomes. As new properties have to charge higher rents to be viable in the face of rising construction costs, existing core properties are forecasted to raise rents with less risk of losing tenants. However, according to the report, the upward spike in construction cost is likely to limit new space available for lease—another positive for rent growth. It indicated a further upside in core rents and valuations, given the economy and demand continue to hold up.
Speaking of REITs, the report stated that volatility has returned to the equity markets including the REIT space. It pointed out that REIT equity is far more volatile than the value of its underlying real estate, on account of its varied investor base comprising ETFs, hedge funds as well as momentum players. JP Morgan Chase indicated that investors may want to consider investing throughout the REIT capital stack and buying the debt—approaches that will meaningfully reduce a REIT portfolio’s volatility and offset the leverage embedded in REIT equity. The report also suggests the use of liquidity and volatility of the REIT market to potentially enhance returns.
“Even in a market that is largely priced to perfection, knowledgeable, experienced global investors with a broad toolbox can find a robust set of attractive real estate opportunities,” the report reads.
At a macroeconomic level, the report highlighted that tighter labor markets and rising wages have begun pushing prices higher across the developed world, while weaker currencies and higher commodity prices have lifted inflation in emerging markets. U.S. economic growth is forecasted to average around 3 percent through the middle of 2019.
Globally, core real estate returns have averaged just over 10.5 percent since late 2010, the report revealed. Valuations have been a significant driver of those returns, however, leaving much of the real estate market fairly priced.