Real estate – what’s next?

Real estate – what’s next?
Pedro Siza Vieira

In particular, the decade following the global financial crisis has brought negative interest rates and growing asset prices, facilitated by high leverage and the appetite of investors for higher returns. During these last decades, real estate was an asset class of choice for investors, consistently delivering high yields, particularly in those locations which were benefitting from international investment due to their integration in the globalized economy.

These certainties have been smashed in the last couple of years. A globalized and integrated world economy requires trust between players and the smooth working of logistics chains. But the Covid pandemic has alerted the world for the risks and tensions inherent in overextended value chains; and the growing geopolitical tensions between the US and China have damaged the trust between the two major poles of the world economy. More recently, Russia’s invasion of Ukraine has shown that dependency of critical supplies, particularly energy leaves western democracies particularly at risk. Governments in Europe and North America have reacted by engaging in the economy in a manner not seen since WWII - by focusing on an industrial policy which seeks to build strategic autonomy in respect of critical technologies and supplies, including energy.

In the meanwhile, the war in Ukraine has disrupted the world markets for materials, particularly in respect of energy. In Europe, natural gas currently trades at a price 10 times higher than a year ago, and that in turn has forced electricity prices up to levels unthinkable just a few months ago. The spike in energy prices dwarfs the shocks in the oil markets of the 1970s. Inflation has returned to the west, abruptly and significantly. Central banks, after initial hesitation (given a still uncertain recovery post Covid), seem now determined to bring inflation down, by raising interest rates and trying to repress demand - even at the cost of a recession. Interest rates are now up and may continue to be raised until inflation subsides.

Inflation, higher interest rates, a path towards de-globalization - will this affect real estate as a preferred asset class? Does the fact that the times of the “Great Moderation” are now behind us mean that real estate - which delivered stable cash flows and high yields - will now be overlooked in the next few years?

I am certain that the novel macroeconomic conditions will have an impact on the investors approach: lower leverage and higher interest costs will impact on valuations and pricing. Uncertainty on inflation will impact on how occupants and owners will address rent escalation. But ultimately, what drives the market is demand, and I believe that demand will remain strong in the western world and particularly in Europe. On the other hand, I feel that macroeconomic conditions will not prevent in the long term the development and growth of the industry.

Let us look at demand first. The most obvious consequence of the geopolitical tensions and the so-called deglobalization is an effort to increase capacity for manufacturing and energy independence in the western world. It will also require significant investment to build redundancies in the value chains on which the west is reliant. These movements will be supported, politically and financially, by governments; they will require significant increase not only in technological capabilities and manufacturing, but also in areas such as logistics. They will be accompanied by investments to tackle and mitigate climate change, from energy efficient buildings to new factories and warehouses. They will also require investments in the renewal of cities to adapt them to a changing climate and in the new housing – a topic that in western cities is now becoming a critical political point.

As to the macroeconomic conditions, we can certainly expect that inflation will lead to higher interest rates, and probably some recession later this year and early 2023. But interest rates are still historically low, and the major factors for inflation (essentially, higher energy prices and bottlenecks on the supply side) will be subsiding as the west tackles its causes. In the meanwhile, whilst inflation will impact adversely in disposable incomes, this will be at least partially offset by the strong employment numbers in both sides of the Atlantic and the growth in wages that it will generate.

As for Portugal, as one of the main beneficiaries in Europe of the reindustrialization movement (given lower energy costs through higher penetration of renewables and direct access to LNG) and where an inflow of foreign residents continues to be felt (low cost of living, safety and quality of health care, geographic location), the demand for high quality real estate will continue strongly in the next decade.

Iberian Property logoIberinmo logo
Iberian Property is the best platform for investment in Spain & Portugal. Created for those who seek reliable information about players and deals happening in Iberia. Through updated database, reports, market indicators and daily news, we report “Who’s Who” in Iberian Real Estate!. Iberian Property is also proud to organize the most important international real estate investors’ meeting in Iberia - Portugal Real Estate Summit!