The Reader’s Digest has many claims to fame. Perhaps the least noted is a quote that appeared in the January 1957 magazine, often misattributed to John Lennon. “Life”, said comic strip author Allen Saunders, “is what happens to you while you’re busy making other plans.”
Investors relying on the IMF’s global growth forecasts for 2020 would appreciate the sentiment. After a sharp slowdown in 2018 global growth to 3.6%, 2019 slowed further to 2.9%. Prior to coronavirus, the IMF expected a pick-up to 3.5% this year (1).
Those figures are now likely to be revised downwards, with IMF head Kristalina Georgieva offering additional support, particularly to poorer countries by way of grants and debt relief, to deal with a potential virus-induced slowdown. She does, however, expect the impact to be “relatively minor and short-lived”. I guess we’ll see about that.
Even before the virus outbreak, momentum in manufacturing activity had weakened to levels not seen since the global financial crisis. Rising trade and geopolitical tensions have increased uncertainty about the future of the global trading system and international cooperation more generally, taking a toll on business confidence, investment decisions, and global trade.
With the headlines consumed by COVID-19, these concerns may appear to have receded, replaced by talk of supply chain concentration and the like. Unfortunately, they have not gone away. These remain risks worth watching.
However, things aren’t all bad. The current US business cycle is now entering the 11th year of economic expansion, the longest on record, US unemployment has fallen to a 50-year low and consumer confidence is near a 20-year high.
Still, the political cycle always offers the potential for a sudden change in direction, forcing investors to reassess asset quality and prices, just as they have reassessed stock valuations in recent weeks. Prior to the outbreak, the biggest event this year was the US election, where a Trump defeat could see a major change in policy priorities, for better or worse. Once the virus passes, this issue is likely to return to the agenda.
Brexit will also remain a major focal point with negotiations on how the UK exits the EU by the end of 2020. A hard Brexit would not be great but both sides have a strong interest in finding a way through the mess.
However things play out, REITs remain well positioned. With the global real estate investment management industry more than doubling in size over the past five years, according to IPE Real Assets, from €1.62trn in 2014 to €3.6trn today, we expect continued positive returns in 2020.
There are, however, seven key themes that advisers and investors should consider:
- Lower for longer is good for yield-orientated sector – Governments around the world are already talking about interest rate cuts in the face of COVID-19. Some central banks, perhaps including Australia, were thinking about it even before the outbreak. This strengthens the lower-for-longer case. As central bankers cut rates the hunt for yield is likely to intensify. That should be good for REITs.
- Growth versus value differentials increase – The differential between the valuations placed on industrial REITs, which have been flying, and retail REITs, which are struggling, has rarely been greater. As the fears around the shift to ecommerce intensify, retail REITs, where valuations aren’t demanding, are likely to remain under pressure. This opens the door to a possible rally among retail REITs that could see the valuation differential close.
- The direct/listed property gap is closing – Following the strong performance of the listed sector in 2019, the differential between direct and listed property has narrowed.
- Cap rates could fall further – Whilst capitalisation rates are low, they could edge lower given global conditions and the need for stimulus as a result of the coronavirus. This strengthens the lower-for-longer environment but, with cautious economic outlook, don’t bank on material yield compression.
- Service, flexibility and shorter leases are in vogue – Whichever way WeWork goes from here, its impact is clear. The co-working sector at large has helped to uncover strong demand for flexible, service and amenity-rich real estate. Even if WeWork goes away the demand for such spaces is unlikely to.
- Political influence will be significant in 2020 – To the virus outbreak we can add the US presidential election, Brexit and the growing influence of political extremism.
- ESG is now mainstream – Environmental, social and governance considerations are gaining traction rapidly. Management teams are now recognising their importance to a range of stakeholders, to the point where portfolios that don’t meet sustainable criteria may struggle to attract tenants.
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(1) World Economic Outlook, January 2020. https://www.imf.org/en/Publications/WEO/Issues/2020/01/20/weo-update-january2020
and yet the XPJ index is at 907, lower than it was back in 2000 !