Curlow's convictions: Equity getting back in the frame

Central bank policy to support stabilising values: Rate cuts continue to be the focus of central banks around the world despite volatile economic data. While there remains uncertainty around the ultimate timing and quantum of cuts, the direction of travel is supportive of a stabilisation in property values. Following nearly two years of price adjustments, Europe is showing signs that pricing equilibrium is fast approaching whilst the US market is taking longer to correct. As positive gearing returns, more debt capital becomes available and equity investors become more confident about valuations, we expect a growing level of transactions volumes during the second half of 2024 followed by a rebound in activity 2025 as the next growth cycle commences.

Defensive sectors to remain in focus over the short-term: The looming risk of an economic slowdown which is prompting central bankers to adopt a more accommodative stance towards policy, continues to lead real asset investors to focus on defensive sectors. These segments benefit from structural demand-side tailwinds which should support a more resilient income stream. The ongoing ‘beds and sheds’ theme, along with some alternative property sectors and essential infrastructure are well positioned to continue to attract capital in this environment. The more significant repricing of the logistics sector combined with strong, albeit moderating, rental growth prospects is likely to see this sector be amongst the first to experience inward yield shifts. By contrast, the more limited value declines in the multi-family sector, combined with affordability issues and the risk of further regulatory pressure holding back income growth potential, should see yet another modest valuation cycle in this sector. Life science, student accommodation, renewable energy, forestry/natural capital, data centres, film studios, and self-storage are all garnering strong investor interest given the underlying thematic tailwinds that are supporting the emergence and further growth of these niche segments.

Cyclical sectors set to rebound over the medium-term: As corporates and households emerge from the anticipated economic soft patch, the more cyclical retail and hospitality segments will likely see a return to the post-COVID rebound but over the short term the risks remain skewed to the downside. However, the current outsized yield spread relative to the more in vogue defensive segments may see capital return to these segments relatively swiftly. With investors attracted by stabilising and recovering income streams – which have adjusted to more sustainable levels in the case of retail – and this yield premium, we could see a resurgence in volume surprise to the upside, along with modest capital value growth.

Refinancing risks abound for maturing debt over the coming years: Debt refinancing risk will likely remain challenging in the coming years as asset owners will be marking to market leverage that is notably more expensive than that which is maturing. This should continue to offer higher yielding debt opportunities for capital able to bridge this funding gap but underlying collateral and sponsor quality will remain key.

Equity getting back in the frame: We are currently in the sweet spot of the property cycle to be a lender but investor interest in equity investment is growing. While debt investments have been the focus over the past 12-18 months, as valuations stabilise more investors are considering the current environment as likely to prove an attractive vintage for re-entering the equity side of the market given the lag between making new commitments and seeing equity drawn. Europe is clearly ahead of the US in terms of its repricing, with increasing signs of markets stabilising, and it remains a key area of interest for global capital allocators. Meanwhile, the US continues to grapple with the most significant disruption to the office sector, with defaults rising rapidly and the most marked tiering of the market from both occupiers and investors.

Office malaise rhymes with retail sector but is fundamentally different: Broadly speaking, the office sector’s disruption from hybrid working patterns rhymes with that experienced by the retail sector amidst the rise in e-commerce. The key differentiator between the two is that the underlying office occupiers remain profitable whereas many retailers fell into bankruptcy as they were unable to build a profitable omni-channel business model. In the office sector it is merely a change in employee behaviour that is disrupting the way they interact with office buildings, not a question of underlying occupier solvency which exacerbated the difficulties faced by the retail sector. As such, we will likely see a similar bifurcation in the market that differentiates assets by quality but are unlikely to see a similar level of stress from the underlying occupier base due to insolvencies. Lease expiries will dictate the timing for occupiers to shift their real estate occupational strategies and are therefore key to monitor how this dynamic unfolds.

All data sourced by AXA IM Alts as at July 2024.