With its long history of investing in real estate, Principal Asset Management has a record of seeing opportunities for Asia-based clients where others don’t. We’re focusing on key structural themes, both in Asia and globally, that should support investments in an uncertain economic environment.
The macroeconomic background of rising interest rates has proven challenging for real estate over the past two years. The outlook remains mixed. While markets are pricing in rate cuts this year, a return to the very cheap cost of capital that characterized the period following the global financial crisis is unlikely. That reflects our view that the Federal Reserve will take a more conservative approach toward interest rate cuts due to stickier than anticipated inflation trends.
Against this complex outlook, our global team of more than 300 real-estate investment professionals has used their long experience and over 60 years of knowledge and experience of the market to focus on resilient subsectors supported by robust long-term structural trends rather than cyclical forces.
A Collective Thirst for Data Drives Demand for Data Centres
Data centres are one of the pillars upon which our modern, knowledge-based society rests. The past decade has seen the migration to cloud computing drive the first wave of growth in data-storage capacity. Our team of data centre investment specialists believe a second wave of expansion is being driven by the artificial intelligence (AI) revolution, creating increased demand for capacity across North America, Europe, and the Asia-Pacific region.
The amount of digital data expected to be created over the next five years will be more than double the amount of data created since digital storage was first invented in 1956.1 At the same time, this highly specialized asset class requires expertise in site selection, power availability, and equipment—characteristics that represent high barriers to entry and limit the growth of supply. In the U.S., rising land prices, longer lead times for power and equipment, and labor shortages are all driving up construction costs and further dampening supply.
U.S. Core-plus Private Equity Real Estate
Since central bankers began raising interest rates in 2022 to combat inflation, the commercial real estate capital markets have faced challenges, prompting investors to reevaluate their portfolio strategies. However, the market is now approaching a turning point and is positioned for a revival in transaction activity, following the Federal Reserve’s decision to cut rates by an oversized 50 basis points in September 2024. This shift signals a more favorable environment ahead for investors and renewed market momentum. We believe that commercial real estate investors will have the opportunity to re-engage in the transaction market across a broad risk spectrum and take advantage of more opportunistic pricing as the global real estate recovery takes hold.
Indeed, a sustained growth environment, combined with more accommodating interest rates and significant re-pricing of real estate assets would generate attractive returns for core-plus portfolios through strong income and value growth.
Todd White, Managing Director of Portfolio Management, argues that based on the asset class’s historical performance, it is reasonable to expect that as interest rates move lower, a long period of positive returns benefiting investors with core plus strategies is likely to begin in 2025.
Opportunity Knocks in European Hotels
The European hotel sector is benefiting from surging demand as the travel and tourism industry bounces back from COVID-19. We anticipate that robust growth will continue over the long term, underpinned by greater global mobility, the rise of the middle classes in developing countries, and a mounting desire to devote more time to leisure activities and memorable experiences.
At the same time, “the structure of the industry in Europe is creating favorable opportunities for acquisition and repositioning,” says Graeme McCormack, Head of Hotel Fund Management. He explains that this is because independent hotels account for the majority of rooms in Europe; by contrast, hotel chains have a much higher penetration rate in the U.S. Yet, while many of these independent properties are very well located, they have suffered from years of underinvestment due to their ownership structure, which tends to be smaller groups or families which own one or two hotels. In 2021, for example, while independent, family-owned properties accounted for 57 percent of rooms in the European hotel industry, they received only 36 percent of total investment.
Currently, there is an opportunity to acquire these hotels at a discount, with high inflation and rising interest rates exacerbating financial weaknesses caused by the COVID-19 travel shutdowns.
Graeme also notes that the strong performance of leisure and hospitality across southern European countries in particular is already attracting the attention of investors and global brands, especially in the luxury and economy segments.
Opportunities Among Global REITs
Global REITs have performed well since June due to the market anticipating the start of interest rate cuts and Federal Reserve easing. Late-cycle economic conditions and declining yields have driven equity investors into REITs, reflecting their long duration and defensive nature, as well as relatively cheap valuations. We anticipate that lower yields could spur a recovery in underlying real-estate values, as long as the economy does not experience a significant setback.
We believe REITs offer a compelling opportunity to add real estate exposure to an equity portfolio. We particularly favor REIT sectors such as senior housing, single-family rental, and cold warehouse storage facilities. REITs is likely to have “first-mover” advantage over private real estate when the recovery in real estate generally gets underway. That reflects the liquid, publicly traded nature of REITs.
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Source
Data as of 30 June 2024, unless otherwise noted.
1 BusinessWire, Data Creation and Replication Will Grow at a Faster Rate Than Installed Storage Capacity, March 24, 2021, IBM.
The information in this document contains general information only on investment matters and should not be relied upon nor should it be construed as specific investment advice, an opinion or recommendation. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however we do not independently verify or guarantee its accuracy or validity. Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this document. All expressions of opinion and predictions provided herein are subject to change without notice. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security. Investing involves risk, including possible loss of principal. Past performance does not guarantee future return.
Potential investors should be aware of the risks inherent to owning and investing in real estate, including: value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk, and legal risk. Infrastructure companies are subject to risk factors including high interest costs, regulation costs, economic slowdown, and energy conservation policies. This document is intended for sophisticated institutional and professional investors only.
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