Could inflation be an opportunity for real estate investments?
BNP Paribas Wealth Management released its global real estate market overview, delivering insights for High-Net-Worth investors wanting to diversify their wealth.
Three key take-aways on real estate investments, either direct or through funds:
- Interest rates adjusted for inflation should remain more or less stable. However, investors usually start to get nervous when they feel rates are increasing, especially for very liquid property shares.
- Property should be purchased primarily because of its intrinsic qualities like net rental yield, protection against inflation or for the tangible character of the property, and less on capital appreciation returns.
- Recommendation remains to invest in the ‘value-added’ property segment, especially in Europe (including the United Kingdom), even if market conditions deteriorate in the next months.
- This could be done either through direct purchase or with the acquisition of units in a ‘real-estate private equity fund’, with a manager who creates value on his/her own (cheaper acquisitions, extension of existing buildings, office to flat conversions, etc.).
"Value-added" real-estate investments generally focus on properties that have already cash flows in place, but seek to increase those net rental streams over time by making improvements to or repositioning the asset. Once the manager has increased the property's net operating income, the property may be sold to collect the incremental value resulting from this 'value-added' investment approach.
“These are interesting times for real-estate investors. Nominal interest rates remain relatively low in many countries of the world, even though monetary policy is set to change. Moreover, it has become clear in recent months that investors should demand an adequate risk premium to compensate for specific property and market risks.”
Head of Real Estate Investment Strategy at BNP Paribas Wealth Management
“Property should be purchased primarily because of its intrinsic qualities like net rental yield, protection against inflation, or for the tangible character of the bricks and mortar. Nonetheless, exchange rate fluctuations are also an important factor to be considered in an internationally diversified property portfolio.” added Pol-Robert Tansens, “but we never recommend or discourage real estate on the sole basis that exchange rate effects may lead to gains or losses.”
Even though real estate returns have been highly differentiated, both commercial and residential performed quite well in recent months. Unleveraged total returns – rental streams and capital appreciation – have been satisfactory in many parts of the world, sometimes cruising at double-digits:
- USA: Despite the structurally higher nominal long-term interest rates in the US (compared with Europe), real estate investments continue to perform nicely, especially in the industrial, office and residential segments.
- Continental Europe: the region is on track too, with Germany shining as top-performer. France is also performing relatively well.
- The UK: considered a more complicated market, much will depend on the outcome of the Brexit negotiations. Failure to reach a deal could have drastic consequences on total property returns. BNP Paribas Real Estate's predictions are not rosy in the event of a worst-case scenario.
- APAC: Even if some markets may be in the final phase of the current market cycle, Asia should not be excluded from a property portfolio. Total property returns can be higher than in other core economies. Offices located in Hong Kong, with projected total returns of 15% this year, are a good example of this.
What about interest rates?
“Much ink has been spilled about the impact of higher nominal long-term interest rates on property returns, and this usually fuel nervousness, especially for very liquid property shares.” mentioned Pol-Robert Tansens. “However, we remain of the opinion that a modest rise in rates is not necessarily bad news for real-estate investors in the long term. This may encourage core inflation, and thus better economic growth prospects. In other words, the interest rate adjusted for inflation should remain more or less stable.”
Confirmed real-estate investment strategy
Even if market conditions may evolve, BNP Paribas Wealth Management strategy is maintaining its real estate investment strategy for its private clients, with a particular recommendation for the ‘value-added’ property segment, especially in Europe (including the United Kingdom), either through direct purchase or with the acquisition of units in a ‘real-estate private equity fund’.