After two years of consecutive losses, the global real estate market saw a positive turn in the second quarter of 2024, indicating a potential recovery on the horizon. This shift comes after a period of high interest rates that drove real estate values to soar, with global total returns reaching 5.0% quarter-over-quarter in the fourth quarter of 2021 and 17.8% year-over-year in the first quarter of 2022. However, as interest rates tightened, these gains were erased and values worldwide returned to 2018 levels. As we believe that the correction in the real estate market is nearing completion, now is a favorable time for investors to reexamine this asset class. Real estate has historically offered stable income returns and diversification benefits in the long run, and has the potential to deliver strong returns during recovery periods. For instance, following the recession in the early 1990s, investors saw a cumulative return of 76% over the next five years. This trend continued after the tech-wreck and the Global Financial Crisis, with cumulative total returns of 98% and 86% respectively.
In the second quarter of 2024, global real estate experienced a moderation of value losses to 0.74%, the lowest quarterly adjustment in the past two years. Coupled with offsetting income returns of 1.07%, this resulted in a positive return of 0.33%, the first positive quarter since the second quarter of 2022. Of the 15 global markets in the MSCI Global Property Index, a majority saw increases in real estate values for the first time since the second quarter of 2022. Eight markets, including Japan, South Korea, Singapore, Southern Europe, the Nordics, the Netherlands, France, and the UK, experienced value growth from the previous quarter. Meanwhile, six markets saw value losses between 0.3% and 1.5%, all of which were lower than the first quarter of 2024. The only exception was Australia, which recorded a larger write-down in the second quarter than in the first, with a 4.2% correction aligning valuations more closely with its peers. However, it is important to note that changes in capital values are just one aspect of real estate returns, with income returns being historically the larger component. This further emphasizes the need for investors to consider both capital and income aspects when evaluating real estate investments.
Overall, income returns remained stable and were a primary reason for investors to enter the real estate market. In the second quarter, total returns, which combine capital and income returns, were positive in 12 of the 15 countries included in the MSCI Global Property Index. In the US, total returns were flat at -0.09%, slightly negative in Ireland at -0.22%, and significantly negative in Australia at -3.07%. However, preliminary data from the NCREIF ODCE index (a capitalization-weighted, gross-of-fee, time-weighted return index) showed US total returns turning positive at 0.25%. With values starting to rebound, we expect this positive trajectory to continue.
Looking to the Asia Pacific region, fundraising for real estate investment is showing signs of a potential rebound globally after two slow years, but China and Japan may face challenges. In the third quarter of 2024, China and Japan accounted for 27% and 15% of the US$7.5 billion ($10.04 billion) in cross-border inflows in the Asia Pacific region. Over half of Japan’s inflows came from global sources, while most of China’s came from within the Asia Pacific region, particularly Hong Kong and Singapore. However, both countries face high debt costs and other factors that may hinder a strong rebound in real estate capital inflows.
In China, there has been a significant decline in interest in Chinese real estate from the West due to geopolitical and economic concerns. Despite Beijing’s recent major stimulus package, it is unlikely to see a return in the near future. The market has remained stagnant due to price dislocation, geopolitical risks, and lack of liquidity. Additionally, China has been facing a property crisis since 2021, intensified by the collapse of Evergrande. This has led to many European investors avoiding China and Hong Kong, despite potential returns. Additionally, China’s domestic property crisis continues, with high office vacancies and low rental yields, as well as ongoing issues with failing developers and government interventions.
In Japan, interest rates remain high compared to other major markets, such as the US, which have cut rates to boost property investment. This has resulted in the broader Japanese property sector losing its appeal due to interest rate policies and limited capitalization rate compression. In July, the Bank of Japan raised borrowing rates for the first time since 2007 in an effort to control inflation, making the market less attractive to investors. This hike has also prevented capitalization rate compression, meaning that property prices have not risen, forcing real estate holders to rely on historically low-income yields. However, senior housing in Japan remains an attractive niche due to the country’s aging population, with 29% of the population aged 65 or over. These assets are smaller and require an amalgamation approach by investors.
On the other hand, Australia’s purpose-built student accommodation (PBSA) market has significant potential due to a shortage of housing. Currently, only 20% of students in Melbourne and Sydney can be accommodated by universities, forcing the rest to seek private rentals. Additionally, real estate debt in Australia offers appealing risk-adjusted returns, as there are funding gaps in construction. This presents opportunities in sectors such as logistics or PBSA, where we see long-term growth potential.
Overall, real estate fundamentals are stabilizing, with valuations and transaction market prices suggesting that the market is nearing its bottom. However, this does not necessarily mean it is an attractive entry point. For market pricing and valuations to increase, we would ideally see declining interest rates and strengthening property fundamentals. With most developed market central banks beginning to taper interest rates, we expect this to put downward pressure on financing rates, discount rates, and property capitalization rates, thereby increasing the value of real estate assets. The pullback in construction activity across sectors is also a promising sign for property fundamentals in the medium term. With supply challenges easing, markets with positive demand due to population growth or structural changes, such as e-commerce, are expected to see higher occupancies in the medium term. Historically, occupancies and rental growth are well correlated, providing investors with opportunities to benefit from increased occupancies, rents, and the associated rise in property values.
While the outlook for global private real estate appears to be improving, it is important to note that not all markets and property types will perform equally well. For instance, the US office market still faces significant challenges, and a broad recovery in that segment seems unlikely in the near term. This highlights the importance of research and selectivity when investing in real estate.
In an uncertain economic and geopolitical environment, additional risks are inevitable, but this applies to all asset classes. Over the past two years, the weight of real estate in investors’ portfolios has significantly decreased due to resetting real estate values and a record stock market. Today, investors may consider adding fresh allocations to the private real estate market to achieve a strategic weighting. Over the long term, private real estate offers low correlations to other asset classes, strong income returns, and a degree of inflation hedging. While there may be bumps in the road, we believe that the market is starting to look up, presenting excellent investment opportunities for savvy investors.