Commercial real estate is what big investors should be looking for right now
A rise in interest rates and an inflationary environment have always been favorable to real estate performance. But above all, understanding investor demand and long-term secular trends is the focus when looking to deliver superior investment returns.
Investing in multiple regional real estate markets and investing in both direct real estate and REITs (Real Estate Investment Trusts) can help maximize the benefits of real estate diversification. Many private real estate investors worry about rising interest rates increasing the cost of debt and driving its value down.
However, with funds that focus on institutional-grade real estate, where most investors use little or no debt, the cost of leverage isn’t as important a driver of value. of real estate compared to private real estate owners. What we find is that there is little connection between institutional real estate values and rising interest rates. Historically, commercial real estate returns, particularly in the United States, have been excellent during periods of rising interest rates when tied to economic growth.
Investor demand and economic growth have a much greater influence on real estate values than interest rates. In short, while it is important to monitor interest rates as part of the overall environment, there are other more relevant factors to consider when assessing the value of real estate.
Real estate offers stability and is seen as a good hedge against inflation which, in an environment of stock market uncertainty and fears of rising interest rates and inflation, contributes to support strong investor demand. It is this investor demand that has a greater effect on value than inflation.
That ultimate hedge?
That said, property returns are more strongly correlated to inflation than stocks or bonds, which is clearly a positive in an inflationary environment. This is, in part, derived from leases creating a revenue stream that can adjust for inflation. This is why investors use real estate as a hedge against inflation.
In the United States, a closer analysis of historical information shows that commercial real estate has generally outperformed during periods of high inflation. Similar trends can be observed in Europe and Asia.
Although interest rates and inflationary pressures have some influence, better understanding how we use real estate to consume, live, innovate and connect – CLICK – allows us to match uses to secular trends that create demand long-term real estate. This approach is the one that best represents the evolving range of opportunities that real estate offers to investors.
For example, changing consumer behavior, changing demographics, and ongoing urbanization are all creating a shift in demand patterns for real estate. People need real estate for many different reasons. Understanding how we live and work, connect and consume can not only help uncover new investment opportunities, but also identify real estate products that may have a limited depth of demand.
When it comes to sustainability and the environment, real estate is an asset class where it is possible to have a direct and demonstrable impact while adding value to the investment. One of the main reasons to invest in real estate around the world is that not all trends are the same. We see different opportunities in different markets.
Different ways to inflate
For example, at first glance, inflation in the United States and Europe looks like similar trends. However, it is worth looking into a little more detail. In the United States, inflation is mainly due to the imbalance of supply and demand from businesses, labor shortages and the expansion of the money supply.
In Europe, however, the main contributor to inflation is the cost of energy, which has clearly increased recently. Although the drivers of inflation and the outlook for rising interest rates around the world differ, what is consistent globally is investor demand that is supporting real estate values and, in many sectors, with occupant demand outstripping supply supporting rental growth.
Real estate returns are driven by human needs. How these combine with the influence of various global structural trends and economic cycles determines current and future demand. Investing globally provides the opportunity to overweight or underweight regions and countries depending on where we expect the highest returns to be generated.