Five growing risks to real estate

Commercial real estate is a global investment market, meaning myriad factors – from trade wars to hedging costs – threaten to upset the sector’s smooth running.

The global appeal of commercial property as an asset class was highlighted by preliminary data from Real Capital Analytics, referenced in a paper on real estate prospects published this week by UBS Asset Management.

In total, property trading volumes of $187 billion were recorded in the second quarter of this year, $10 billion over the long-term average. Although that figure represents a slight drop from the previous quarter and the same three-month period in 2017, global property investment has, broadly, remained stable so far this year.

European capital markets, however, have slowed somewhat, with Q2 volumes 20 percent down on 2017. As UBS noted in its Real Estate Summary research, the economic backdrop has become more challenging. These five risks, highlighted by UBS, should be on debt players’ radars.

1. The prospect of a trade war: Cited by the bank as the main threat to economic expansion – and demand for property space – the risk of trade conflicts between the US and its NAFTA partners, as well as China and the European Union, have escalated. European fears were somewhat calmed in July when US president Donald Trump and European Commission president Jean-Claude Juncker agreed to work towards zero trade barriers. Given Trump’s record of inconsistency, however, this cannot be taken for granted.

2. Fear of the yield gap: Although it is playing out on a measured basis, global monetary policy tightening and rising long-term bond yields are affecting real estate sentiment. As UBS points out, investors are approaching a scenario where they might have to choose between Paris offices yielding 3 percent and 10-year US treasuries paying the same. Rental growth in certain markets is helping mitigate the situation, but the narrowing of the yield gap remains a long-term threat.

3. Weakening European economic indicators: Eurozone GDP projections for 2018 are unchanged at 2.1 percent, but are forecast to weaken in 2019. Several individual scenarios are playing out; the impact of rising social security contributions in France, the uncertainty of the Italian populist government and the growing prospect of a no-deal Brexit. Europe’s growth story is not over, but it is less compelling in places.

4. The rising cost of currency hedging: Given real estate investment’s global reach, the rising cost of foreign exchange hedging instruments – which typically comes back to interest rate differentials – requires attention. The gap between US rates and the eurozone is widening. This heightens the cost of hedging for investors from low-interest-rate economies, so may be less of an issue for capital coming into the eurozone, however.

5. The disquiet created by the retail crisis: Will Europe witness a ‘retail apocalypse’, asked UBS? Perhaps a strong word, but with retail a major component of many investor’s portfolios, the crisis in the sector – especially in the UK – could prompt a rush of disposals, exacerbating a correction in values. The opportunistic will make the most of the residual value of well-located shopping properties, but as a signal of the impact of demographics on the fundamental need for certain types of property, the retail crisis will spook many active in real estate.

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