International and Emerging Real Estate Semi-Annual Outlook

May 2023*

Some Bright Spots for Global Real Estate

The real estate sector faces many challenges, from a global slowdown to elevated interest rates. However, the global tightening cycle appears to have peaked, which should provide relief to real estate assets. Meanwhile, China’s reopening is a boost to some ASEAN markets. Therefore, we think there is value in listed real estate.

Over the past six months, real estate returned 7.6% in US dollar terms as stronger-than-anticipated data buoyed stocks. Nonetheless, it was the second-weakest asset class after commodities, a repeat of the prior period. The headwinds of elevated rates and slowing growth are particularly acute for cyclical assets like real estate. Indeed, property service provider JLL note that global direct investment fell by 56% yoy in Q1 due to uncertainty and high borrowing costs, while the bid-ask gap is wide. 

The outlook has improved since the last Real Estate Semi-Annual. First, the Fed has seemingly paused its tightening cycle, which should support valuations. Second, China’s exit from its zero-Covid policy paves the way for a revival in Chinese activity and, more importantly, Chinese outbound tourism. As the biggest beneficiaries of the latter, we prefer ASEAN markets to gain exposure to China’s reopening. Third, while real estate valuations (as measured by the FTSE EPRA Nareit Global Index) are less attractive than US 10-y yields, the spread to equities (as measured by the MSCI ACWI Index) has widened. As such, we think real estate as an asset class retains value, but we are selective at a market and sector level. 

Office: Global office leasing activity slipped up in Q1, dropping by 18% yoy. Occupiers are reportedly pausing expansion plans due to the global slowdown and the continuing transition to hybrid working. Construction delays mean development cycles have yet to peak in Europe and Asia Pacific, which could weigh on rents. High-quality assets should continue to perform well, especially as sustainability requirements become more widespread. 

Retail: The post-lockdown recovery in the retail sector has matured in the US and Europe but still has further to go in Asia. Consumption has been supported by tight labour markets, helping the retail sector fare better than anticipated in a rising cost environment. Following a sharp derating and slowing e-commerce growth, there is a case to be cautiously optimistic in specific segments of the market, namely luxury and those in high-quality locations. 

Residential: Monetary tightening, while tempering house price growth in a number of markets, has not caused a collapse in house prices. Structurally undersupplied and benefiting from urbanisation trends in emerging markets (EM), the residential sector is still sought after by investors.

Industrial: Activity is starting to cool as the economic backdrop becomes less supportive. Also, vacancy rates could creep up as new supply feeds through. Longer term, nearshoring trends and scope for rising e-commerce rates in EM will drive occupier demand. 

Market Strategy

EM real estate (as measured by the FTSE EPRA/NAREIT Emerging Index) outperformed DM (Developed Markets) ex-US real estate (as measured by the FTSE EPRA/NAREIT Developed ex-US Index) by 10.2% points over the past six months. The dividend yield gap between EM and DM ex-US real estate equities has narrowed, reflecting EM’s large weighting to China, which has recovered sharply since reopening. As such, there are still good opportunities within EM and we maintain our overweight

Among DM, we upgrade the UK to overweight, as we are cautiously optimistic towards the retail sector, and stocks appear very cheap. In Hong Kong, neutral valuations and an improved outlook mean that we upgrade our allocation to neutral. We downgrade Singapore to underweight as the new tax on foreign ownership means there is scope for real estate stocks to derate. 

Among EM, we downgrade China to underweight due to structural weakness and South Africa to underweight due to energy disruptions. We upgrade Indonesia to overweight as we are constructive on the medium term, and current valuations provide an attractive entry point. 

International Allocation Breakdown

  Chg -2 -1 0 +1 +2
Hong Kong        

EM Allocation Breakdown

  Chg -2 -1 0 +1 +2
South Africa        

*The publication reflects asset performance up to April 28, 2023, and macro events and data releases up to May 15, 2023, unless indicated otherwise. Data about real estate rents, net absorption and supply are from JLL.

The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.