UBS Unveils Top Ten Questions for Real Estate

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6. Is core overpriced relative to value-add, or is a levered core a safer investment strategy?

This question typically arises after a period of high returns, as the performance starts to «normalize». This time there are also very low absolute yields across assets. Investors are drawn to any undertaking with expected returns closer to recent history. Often, risks are dismissed because they are hard to measure and economic weakness is a distant memory. Value-add investments typically trade away current yield for higher capital growth. It should be noted that the volume of value-add available at any given time is a small portion of the core volume available.

Furthermore, value-add is project-specific. There can be a wide range of outcomes depending on individual conditions. UBS's current outlook is that interest rates, and thus required yields, will remain low and economic growth will be positive but also low. As such, we might expect that core investment will be low yielding. Thus we argue that core is not over-priced relative to value-add. Rather, both strategies are responding to the current environment. Investors should anticipate low yields paired with modest growth and a wide range of value-add outcomes.

7. Supply gaps and deteriorating affordability have boosted multifamily. Is this an investment opportunity or a social risk?

Multifamily investment is on the rise, going from 13 percent of global transaction volumes in 2009 to 23 percent in 2018. Interest is supported by structural demographic changes such as growing urban populations and delayed family formation. As it is, rising rents and the lack of affordable housing are increasingly part of the populist agendas in many countries, exacerbated by slow policy responses on the supply side.

For the multifamily investor, changing government policy is a key risk since lawmakers have an incentive to tackle this issue; e.g. through the rental caps imposed in Berlin, Dublin, and parts of the US. Conversely, it also points to potentially favorable policy responses, such as in Australia, where the government increased the capital gains tax discount to investors in affordable housing. Seen from a positive angle, this underscores the role that the private sector can play in addressing a pressing social need, if handled appropriately.

8. Allocations to real estate remain high. What is the next source to drive global capital flows?

Dry powder for private equity real estate was estimated to be in excess of $320 billion at the start of 2019. This sum is unlikely to reduce much in the year ahead, particularly in a low rate environment where real estate is relatively attractive vis-à-vis other asset classes.

We expect cross-border investors to remain active in 2020. The growing fiscal burden of deteriorating demographics across the globe is hastening the search for higher-yielding income-producing investments. This is unchanged from recent years, with the subtle difference being an ostensible urgency to deploy into real estate.

We anticipate that Japanese pension funds will dip their toes deeper into direct real estate in 2020. This has been a very gradual process. Anecdotal evidence suggests that Japan's institutional funds have made substantial allocations and are focused on the mature core markets of the US and Europe. In addition, the tremendous wealth creation experienced in the last decade has led to many family offices, particularly in Asia and the Middle East, looking to deploy systematically into global real estate. We believe this will continue in the year ahead.

9. What do public real estate markets suggest for a private market performance next year?

2019 was positive for listed real estate, in line with equities overall. The performance was comfortably into double digits attributable to resilient market fundamentals and accommodative monetary policies. However, not all sectors and regions performed equally, which provides some useful pointers for 2020. In terms of geographies, the outlier was, unsurprisingly, Hong Kong where returns were negative and the discounts to NAV were close to 50 percent. In contrast, Japan REITs are trading at double-digit premia, which points to a high level of investor confidence in this market.

Not surprisingly, many of the retail specialists recorded negative returns and are closing the year with discounts to NAV (suggestive of further struggle). However, retail performance varied significantly: investors are not punishing the sector irrespective of the underlying portfolios. In the U.S., for example, REITs focused on regional malls suffered much more than those investing in shopping centers.

Office-focused firms provided positive returns in most cases, although prices were at a discount to NAV in both the U.S. and Europe, which suggests a cautious outlook. This is not the case for industrial and residential specialists, which typically trade at a premium, pointing to further outperformance for these segments. Finally, niche sectors are often easier to access in public markets and these specialists performed well in 2019, data centers in particular.

10. Demand for flexibility is changing real estate usage eg. e-commerce or flex office. How will this spread to other sectors?

Corporates and end-users are increasingly rejecting the notion that real estate is a fixed cost, and are embracing the concept of space-as-a-service, enabled by shifts in technology. This has manifested itself in self-storage, co-working and short-term accommodation, amongst others.

From the landlord and investor's point of view, the commercial viability of flexible solutions is debatable, at least for now. However, the real estate industry has always been quick to respond to the changing needs of end-users and this cycle is no different.

Looking ahead, we expect the retail and logistics sectors to accelerate the adoption of plug-and-play formats. The retail segment was the first to be affected by technology and changing consumer habits, but landlords are now offering excess space on short leases. There are already aggregators that serve to link up landlords and transitory tenants, and we can expect this trend to pick up as retailers adapt to smaller footprints.

In the logistics sector, pop-up supply chains are evolving. Especially for smaller e-commerce players, temporary and on-demand logistics provide a solution for expanding fulfillment capabilities during peak periods. The logistics sector will see a slight shift from build-to-suit towards a build-to-serve model.