In a new Citi Research report, a team of analysts led by Nick Joseph looks at four macro trends that are impacting real estate globally—an exploration offered in conjunction with Citi’s 29th annual Global Property CEO Conference, bringing more than 175 CEOs to Hollywood, Florida, for meetings and discussions. The conference allows investors direct access to hear the “tone from the top” and better assess how they want to be positioned globally and within each property sector and which stocks they want to own.
The four themes explored herein, and much discussed at the conference, are 1) the macro outlook and its impact on local property markets; 2) capital allocation in a higher rate environment; 3) the impact of AI; and 4) sustainability initiatives.
The authors note that the global real estate sector represents the backbone of the global economy and provides both the physical and digital infrastructure for where we work, shop and play. Real estate is one of Citi’s seven distinct Global Super-Sectors, but the authors note that it’s actually driven and impacted by all the others. Moreover, as landlords the publicly listed companies can shape how corporates and individuals use the physical and digital infrastructure to support and grow their operations.
There are many different property sectors, and even more distinctions as you drill down. That makes the breadth and depth of the publicly listed market significant, and offers many choices. The authors note their view that while interest rates are important in considering real estate investing, what matters more are the property type, geography, management teams and a host of operational, fundamental and financial variables.
Theme 1: Macro to Micro—The Macro Outlook and its Impact on Local Property Markets
Citi’s Global Economics team forecasts global growth to slow to slightly below 2% from a near-trend 2.7% last year. The note takes a country-by-country look at how the macro outlook could impact property markets. Highlights include:
In North America, the authors think the sector’s external growth will likely remain limited in the near term as sellers adjust expectations, buyers react to changes in their cost of capital, financing markets are constrained, and companies re-underwrite development and redevelopment.
Australia’s REITs entered 2024 amid uncertainties about the interest-rate cycle, with those uncertainties negatively impacting transaction volumes and asset pricing to some degree. But the authors note operational earnings have remained resilient, with relatively stable headline rent, vacancies and leasing spreads.
In China, the authors think mid- to long-term decline could prevail over short-term cyclical factors under new demand-supply dynamics. With the physical market still weak, they expect volatile sector performance.
In Europe/UK, the rate decline debate continues to be a significant driver of European real estate stocks, with the timing of cuts the key remaining uncertainty for investors. If a deep recession can be avoided and inflation falls to target ranges, the resulting rate cuts will likely drive better stock performance. But particularly for European real estate, lower inflation may also mean rent growth slows through 2024.
See the full report for additional details and other country-specific discussions.
Theme 2: Capital Allocation in a Higher Rate Environment
The authors note that inflationary pressures have eased but higher interest rates appear here to stay despite potentially more dovish central-bank policies across regions. Interest-rate stability should be a positive for global real estate valuations, but transaction markets remain challenging due to price discovery. And in some regions, development has become more challenging. This has left REITs generally well positioned to benefit opportunistically.
Highlights of this theme’s exploration include:
In North America, the conversation has turned to when a more dovish Fed will begin cutting rates. While there have been signs of modest improvement in the transaction market, the authors note that volumes remain muted given ongoing price discovery and a more challenging financing environment. The authors see stability of interest rates as a potential catalyst to help thaw the transaction market. In commercial mortgage REITs, the authors note that the high-rate environment created pressure for REIT borrowers, with more loans moving into non-accrual status creating portfolio-management challenges.
China’s interest rates have been on a downward trend since October 2021, though the authors note CPI/PPI deflation means real borrowing costs aren’t low. For households, rental yield of ~2% in major Tier 1 and 2 cities still means a negative carry; for landlords, asset return hinges on the occupancy/rent outlook amid macro.
For Europe/UK, the authors note that the higher rate environment in almost all subsectors has caused values to decline due to the direct rate implications and the use of higher rates to slow economic growth, leading to recession risk to rents.
For other country-specific discussions, see the full report.
Theme 3: The AI Impact
The authors note that technology is disrupting real estate in profound ways, as it’s done with all aspects of the economy. The technological-disruption conversation has shifted recently to AI, its potential use cases, and near- and long-term impacts.
Highlights include:
In North America, AI’s near-term impacts are most pronounced for data centers given the impact on increased power demand. More broadly, the authors say, generative AI is likely to be most beneficial for areas of real estate that have a customer-service component which can be outsourced through chatbots or other human alternatives. Overall, the authors say, AI adoption is likely to be more of a medium-term tailwind.
In Australia, the authors note that residential brokers are using AI to predict residential buying and selling, including tailoring lists of homes that suit buyers’ needs. AI is also being used to produce profiles of residential buyers’ demands in the market.
Stepping back from the country-specific discussions, the authors list applications categorized as AI that could gradually impact real estate over time. That list includes enhanced predictive analyses, enhanced property management, leasing automation, and purchase and sale documentation and due diligence. As the race to create commercial solutions accelerates, the authors expect significant growth in the data-center and processing space, a likelihood of accelerated higher-value job growth long-term, and questions about unique data sets and protectionism.
Theme 4: Sustainability Initiatives
The authors note that the conversation around ESG has started to shift, adding that they view sustainability as an area of continuing importance, representing a pathway for companies to demonstrate a commitment to reducing waste, whether energy-related or otherwise. Moreover, they note that the economic benefits are seemingly also measurable.
Highlights include:
In North America, REITs have generally been ahead of the curve, particularly when it comes to sustainability considerations that have been employed to lower operating costs and attract tenants with their own sustainability mandates. The drive for improved sustainability will continue to support gains in resilience, risk management and retention of diverse talent. The authors note that timber REITs appear uniquely positioned to benefit from investor interest in ESG.
In Australia, sustainability reporting has improved considerably in recent years in light of an increasing focus from investors, with most Australian REITs ranking highly in global sustainability indices. The authors call office space the best example of sustainable practices, noting that new developments targeting the best sustainability standards are getting more tenant demand than traditional ones.
In Europe/UK, ESG continues to evolve and gain prominence, creating both positive and negative return implications. The authors note that ESG’s objectives are broadening, targets are becoming more measurable, and timelines are evolving. The authors observe that ESG regulation increases compliance demands and capex and that lack of the highest standard of ESG assets is creating financial opportunities through renovation and development.
In Japan, the authors note that environmentally friendly buildings are in strong demand, a trend they expect to accelerate in the wake of inflation and rising energy prices. The authors see this demand implying a long-term advantage for major developers and home builders with expertise in developing high-grade properties, as well as for large office REITs that own them.
Existing Citi Research clients can follow this link to access the full report, which also explores seven property-sector themes and lists Citi’s most and least favored stocks.
