How direct real estate exposure is tracking in the current market

Economic conditions, including falling cash rates at home and abroad, are prompting investors to shake up their asset allocation. This is having an impact on allocations to direct real estate worldwide.


The state of play

At its October board meeting, the Reserve Bank lowered the official cash rate by 25 basis points to 0.75 per cent.

The RBA is not alone in its fight to kick-start the national economy. Developed nations worldwide are grappling with sluggish growth and below-target inflation figures, and there’s no end in sight for the mid-term.1

“Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation”

said RBA governor Philip Lowe in his statement supporting the cash rate decision.

One well-understood impact of this lower-for-longer environment is compression of returns from traditional safe haven assets like bonds and cash. As a result, institutional and retail investors alike are on the hunt for new opportunities, and we see that manifesting in a jump in investors’ interest in direct commercial real estate.

Key market observations

In the last 12 months, commercial real estate (CRE) has delivered an average return of 4.9 per cent, placing it amongst the highest income return of all asset classes.2

Further, investors worldwide have lifted their exposure to CRE, from an average of 8 per cent in 2012 to 11 per cent today.3  At AMP Capital, we anticipate this figure will continue to rise, reaching approximately 15 per cent by 2025.

However, it’s important to note that while falling cash rates will likely prolong the real estate capital growth cycle, which is currently in its ninth year of positive capital growth, we expect yields to compress in the office and logistics space over the next 12 months, as the cost of capital falls.4

Similar patterns and projections were identified in a report from Cornell University in the United States and capital advisory firm Hodes Weill.5

Its 2018 Allocations Monitor, which includes research collected from 208 institutional investors in 29 countries, said that, on average, institutions are expected to increase target allocations to real estate by 20 basis points over the next 12 months.

Further, the research found that after two years of “moderating” portfolio investment returns, performance increased in 2017. Real estate portfolios generated an average annual investment return of 9.2 per cent in 2017, up from 8.7 per cent in 2016, according to the report.

“This is consistent with industry-wide real estate returns, which trended upward in 2017, spurred by a rebound in economic growth which led to stronger operating fundamentals (i.e. rent and occupancy trends) across asset classes and geographies,” the report said.

Notably, the report also measured institutions’ view of real estate as an investment opportunity from a risk-return standpoint, using a so-called ‘Conviction Index’. After four years of steady declines, this index moved from 4.9 to 5.1.

Interestingly, on the flipside, despite 92 per cent of institutions reporting that they are actively investing in real estate, institutions remain approximately 90 basis points under-invested relative to target allocations, the report found.

One to watch

At AMP Capital, we anticipate the cash rate will continue to fall, potentially as low as 0.25 per cent by early 2020. As a result, we expect the hunt for yields and growth to intensify, as investors search for steady and prolonged sources of income. In this context, real estate will be one to watch as time wears on.


Author: Luke Dixon, Head of Real Estate Research – Real Estate, Sydney, Australia

Source: AMP Capital 10 Oct 2019

Source: IPD/MSCI Total Return Digest, Q2, 2019
Source: Cornell/Hodes Weill & PwC
Source: AMP Capital Real Estate Research as at September 2019

Important notes: AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMPCFM) is the responsible entity of the Responsible Investment Leaders Balanced Fund (Fund also known as the AMP Capital Ethical Leaders Balanced Fund) (ARSN 095 787 723) (Fund) and the issuer of the units in the Fund. To invest in the Fund, investors will need to obtain the current Product Disclosure Statement (PDS) from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital). The PDS contains important information about investing in the Fund and it is important that investors read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Fund. Neither AMP Capital, AMPCFM nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this article. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this article, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to their objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.