OUTLOOK 2023 OUTLOOK 2023 - INVESTING TODAY. FOR TOMORROW - LASALLE INVESTMENT MANAGEMENT
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Outlook
2023
Outlook
2023
Investing today. For tomorrow.
G LO B A L | A S I A PAC I F I C | EUROPE | NORTH AMERICA
Managing editors
Petra Blazkova Richard Kleinman Daniel Mahoney Elysia Tse
Head of Research and Head of Americas Head of European Head of Asia Pacific
Strategy, Core and Research and Strategy, Research and Strategy* Research and Strategy
Core plus Capital, Europe Co-CIO Americas
Julie Manning Dennis Wong
Brian Klinksiek Global Head of Climate
Eduardo Gorab Senior Strategist,
Global Head of Research
Head of Research and and Strategy*
and Carbon Strategy Asia Pacific ISA Outlook 2023
Strategy, LaSalle GPS
Dominic Silman
Chris Langstaff Head of Research and
Jacques Gordon Senior Strategist
Global Strategist Strategy, Debt and
for Canada Value-Add Capital, Europe
Preface p4
Contributors: Research and Strategy team
Mary Burke Ryan Daily Sierra Pierre Matthew Wapelhorst
Frederik Burmester Heidi Hannah Chris Psaras Jen Wichmann
Zuhaib Butt Kayoko Hirao Wayne Qin Jannie Wu
Simone Caschili Kayley Knight Kyra Spotte-Smith Hina Yamada Global Asia Pacific
Jade Cheong Tobias Lindqvist Sophia Sul p6 p 28
Amanda Chiang Ally Muszynski Fred Tang
LaSalle leadership
Keith Fujii Lisa Kaufman Gordon Repp Michael Zerda
Head of Asia Pacific Head of Global Securities General Counsel Head of Debt and
Value-Add Strategies,
Mark Gabbay Tim Kessler Mike Ricketts and Co-Chief Investment
Chief Executive Officer Global Chief Chief Financial Officer Officer, Europe Europe North America
Operating Officer p 38 p 46
Brad Gries Darline Scelzo Matt Sgrizzi
Co-Head of the Americas Philip La Pierre Global Head of Chief Investment Officer,
Head of Europe Human Resources Global Securities
Kristy Heuberger
Co-Head of the Americas Joe Muñoz Claire Tang
Co-Chief Investment Head of Greater China
Samer Honein Officer, Americas and Co-Chief Investment
Global Head of Officer, Asia Pacific
Investor Relations Kunihiko Okumura Published December 2022
Co-Chief Investment Jon Zehner
Officer, Asia Pacific Head of Global
Partner Solutions
*effective 1 January 2023.
G LO B A L | A S I A PAC I F I C | EUROPE | NORTH AMERICA
ISA 2023 Outlook preface
Jacques Gordon
Global Strategist
Thirty years ago, the US and UK were the only two countries
Retrospective: Prospective: In the year 2025
keeps them somewhat accountable, yet their manipulation
that had a decade of private equity property performance of the electorate and ability to control policy severely limits
their capacity to serve all people fairly once they gain power.
A credit crisis led to a in a consistent and transparent manner. In the early 1990s,
Australia and Canada were just getting their indices launched. The lessons of the early Schumpeter’s viewpoints were shaped by being an escapee of
both the rise of fascism in 1930s Germany and of Soviet-style
professional business Global REIT indices were still several years away and private
equity indices in Japan, Germany and France were all still in
1990s are clear: real estate
down-cycles do not last communism of the 1950s—regimes that came to power through
the planning stages. The early 1990s also provided the launch forever. Reflecting on the sham elections. Like the 2525 video, reading Schumpeter
I joined LaSalle Partners in 1994. At that time, real estate was pad for the first institutional-sized “opportunity funds,” which frightening memories of reminds us how the past, present and future all intersect.
in dire straits. A mild recession in the United States (1991), got going wherever real estate debt was in default—which was plummeting values, empty
Geopolitical events in LaSalle’s target countries are as difficult
overbuilding from tax-loss driven “accelerated depreciation” just about everywhere. These opportunity funds along with the buildings, bankruptcies and the
to predict as the idiosyncratic motivations of their leaders.
(1981-1986) and an uncontrolled savings and loan lending binge securitization of debt markets (CMBS) and equity portfolios Resolution Trust Corporation
As researchers, we cannot “know” the future, but we can help
(1986-1995) pushed vacancy rates up to record levels in the (along with good bank/bad
(REITs) were all responses to the “credit crunch” that ensued devise strategies to cope with whatever alternative futures may
late 1980s. As 1994 unfolded, there was still a hangover from the bank government interventions
after a series of rolling bank crises in the US, Canada, the UK arise. The forces of nationalism, authoritarianism and a distrust
S&L debacle. From 1990 to 1993, the National Council of Real in other countries), suggests
and Japan. of globalism may represent a temporary triumph of politics
Estate Investment Fiduciaries (NCREIF) Property Index (NPI) had that the current round of
over economics. Over the long term, though, the power of open
its worst four years since its launch in 1980 (including data back Most discounted cash flow models were done on Excel, which credit tightening is likely to markets remains a force to be reckoned with and not to be
had just arrived on the scene to eventually put Lotus 1-2-3 pale in comparison. The 2023 underestimated. Likewise, well-constructed and well-located
to 1978). In the UK, the situation was not any better. The new
(owned by IBM) out of business. Realm software, which later edition of LaSalle’s ISA Outlook properties can thrive even during periods of great political
Investment Property Databank (IPD) monthly index registered a
became Argus, was first launched in 1985. Only a few firms anticipates the impacts of the turmoil. Successful real estate investing rests on identification
boom-bust pattern of returns in the early 1990s, swinging wildly
rising cost of credit, a stall in of timeless attributes that are successful over the course
from -18% in 1990 to +35% in 1994 and then plummeting again were using it in 1990, but by 1994 its use started to explode
economic growth and a pause of several cycles. These attributes must be appropriately
to zero in 1995 (based on the annualized numbers). and by 1998 it had started to “go global,” gradually picking
in the multi-decade pattern of real estate appreciation. priced and they must also adapt to trends in demographics,
up market share from a handful of other valuation software
Out of this crucible came the first ISA, published in early 1995. However, it does not extrapolate these trends far into the technology, urbanization and environmental factors. This triangle
options in other countries. future. The human tendency to latch onto a few pieces of
My research colleagues and I explained that real estate was of timelessness, adaptation and fair value pricing forms the
In sum, the early 1990s laid the foundation for the maturation of information (usually the most current headline) and to expect foundation for successful real estate investing.
inherently cyclical. We pointed out that the institutionalization,
the asset class. Five pillars provided support: that a narrow set of recent facts will shape future events is
securitization and globalization of real estate was still in As I hand over the reins of LaSalle’s research to a new generation
known as “anchoring bias.” When investing in a long-duration
the early stages. And that the professionalization of the asset class like real estate, a longer-term, holistic view is of researchers, I sense that the past, present and future will
1. Capital market integration as securitized sources
investment management business, signaled by the integration more valuable. continue to intersect and to overlap. The awarding of the 2022
diversified the supply and demand for real estate capital;
of fundamental research, would bring acceptance of the asset Nobel Prize in Economics was based in part on an analysis of the
class and reduced volatility. 2. Risk-return expansion to broaden the range of investment In 2014, the apocalyptic visions of German film director, Fritz Great Depression of the 1930s. We have learned much about
styles available; Lang’s 1927 masterpiece Metropolis were put alongside the credit cycles and the role of banks in maintaining or losing
Now, nearly 30 years later, we know that real estate recovered 1960s rock song “2525.” The irony of bringing together dark confidence in market institutions. At the same time, the events
from these setbacks. In fact, it thrived. The modern REIT era was 3. Yield compression, a three-decade journey that reduced images from one era, while listening to music from another, of 2022 in Ukraine and elsewhere show how unpredictable the
launched in 1994, which provided much-needed equity and the cost of capital for real estate; through the technology of a more recent YouTube artist is “course of human events” can be. The semi-predictable path of
transparency to what had been a clubby, opaque business. In symbolic of how imperfectly clever we are at predicting the rising C02 levels is leading to weather volatility along with rising
the US, private equity real estate recovered and put together a 4. Rising transparency as data on fundamentals, pricing and future. The eerily weird Lang-2525 juxtaposition implicitly atmospheric and oceanic temperatures. How will all this play out
string of 14 years of strong returns, which took a Global Financial capital flows became ubiquitous; and illustrates how resilient humanity can be, even while for real estate? No one knows for sure, but the next generation
Crisis in 2008 to interrupt. In the UK, the boom-bust years in the contemplating what seem like existential threats such as of researchers, strategists and sustainability experts will be at
5. Technology, which has expanded every year as proptech
early 1990s settled down as the Bank of England realized that fascism, industrialization and robots in the 1920s; nuclear LaSalle to help us figure it out.
applications have revolutionized the management and holocausts in the 1960s; financial panics in the 1990s and
lending to property developers required oversight. The result
valuation tools used by practitioners. again in 2008-2010 and climate change and geopolitical
was a golden decade for British institutional real estate between
1996 and 2006, with 11 straight years of performance above the conflict in the 2020s.
long-term IPD average. Even more incredibly, over the next 15 Josef Schumpeter is most well-remembered for popularizing
years real estate gradually became accepted as a global asset the term “creative destruction.” He is less remembered for his
class, alongside equities and fixed income. work on democratic theory. To Schumpeter, democracy is the Global Strategist,
mechanism for competition among political parties in a market- Global Head of Research,
like framework. The process of voting legitimizes leaders and 1994-2022
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Global themes Five global themes going into 2023
A mix of cyclical, structural
and secular factors
• The global economy is experiencing an
1 + -
=
2
+
acute inflationary episode, which most
central banks are aggressively fighting with
tighter monetary policies. This is driving The math of spiking The path of fundamentals will
up borrowing costs and putting downward rates driving a ultimately help determine where
pressure on asset values. As of the time repricing of real estate values settle
of writing, there were tentative signs that
inflation may have peaked but many
3
uncertainties remain.
• The prospects for the depth and duration of
the economic downturn vary substantially
across the globe, with Europe in the worst
position. That said, in most key markets Beyond the sector chasm
globally the balance of real estate supply and – other factors gaining in
demand remains relatively benign, somewhat importance
moderating the sizable drag on total returns
from rising capitalization rates that exists in
5 4
many markets.
• Performance divergences among property
types are set to continue, but investment
outcomes will increasingly also depend
on other factors, such as asset quality, Moving from climate Virtual vs. in-person balance
sustainability attributes and physical awareness to planning close to a post-pandemic
climate-risk differentials. and action steady state
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The global economy and real estate markets are in the throes of an acute episode. G.1
Inflationary pressures were unleashed by pandemic-related supply chain Inflation readings now highest in Europe
Energy prices hitting Europe harder than in any other region
challenges, the frictions of a stop-start reopening, vast fiscal stimulus and pent-up
consumer savings. The impact of these is being exacerbated by a war on Europe’s Inflation trend by country
periphery that is creating havoc with commodity markets, especially those for 12%
energy, chemicals and basic grains.
10%
Calls that inflation and rates were “peaking” or and a bid-ask spread has emerged in many markets,
Inflation rate (year-over-year)
“transitory” proved wrong again and again; the rise in causing a slowdown in transactions (see Exhibit G.2). 8%
inflation has spread beyond volatile commodities into Investors debate whether it is the public or private
6%
core parts of the economy (see Exhibit G.1). Wherever market valuations that are “correct” as the divide
real estate occupational markets have been tight between them is so wide that both cannot be (see 4%
enough to give landlords pricing power, which mercifully Exhibit G.3).
is the case in many cities and sectors across the globe, 2%
real estate cash flows have benefited from inflation. At times like this, it is important to remember that
However, this is a reminder that real estate can act as all crises go through phases. During the earliest 0%
both a hedge for and a source of inflation; surges in phases of an acute episode, it tends to be difficult
residential rents and home prices have also contributed to look through to later phases. The human brain is -2%
conditioned to overweight and extrapolate “what just
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to higher inflation.
happened.” This may have been a useful survival trait
In response to high inflation, most central banks have for pre-literate humans, but we have recorded history,
raised interest rates. These tighter financial conditions learned experience and an ability to conceptualize and Japan China South Korea Australia Singapore Canada U.S. Eurozone U.K
have caused a decline in the prices of a wide range recognize patterns. Insights from all of these suggest
of financial assets. They are also clearly having an that we will eventually transition to a more stable phase. Inflation rate 20-year historical long-term average
impact on private market real estate asset values in
many markets, although transactional evidence is thin We have been here recently. In the 2021 Investment Note: 20-year historical long term average inflation rate is the average quarterly inflation rate since Q3 2002.
and uneven. Listed real estate leads the way in price Strategy Annual, we predicted that the acute phase
Source: Oxford Economics data to Q2 2022; latest monthly data from Australia Bureau of Statistics, Eurostat, Singapore Department of Statistics,
declines, while private real estate index valuations lag of the COVID-19 pandemic would sooner or later Statistics Bureau (Japan), Statistics Korea, National Bureau of Statistics (China), Statistics Canada, Office for National Statistics (UK), US Bureau of
Labor Statistics. Latest data available as of November 28, 2022.
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transition to a “living with COVID” period. We G.2 In this ISA Outlook 2023, we “look through” the current But just as it was with COVID-19, the transition to a
have reached that milestone in most parts of the Transaction volume down meaningfully acute period of volatility and uncertainty to discuss more stabilized state is uncertain and likely to have
world. The virus is no longer a major constraint Most pronounced reduction in activity is in Europe our view of likely outcomes and scenarios to consider, unexpected twists and turns. We have identified five
on life in many countries. While some things key themes for investing and real estate strategy global themes that we think investors should keep in
Year-over-year change in quarterly transaction volume (all
have not returned to the way they were pre- Year-over-year change in quarterly transaction volume recommendations that we expect to be resilient mind as we move through the acute phase of monetary
property types)
pandemic, that has been due to other factors, (all property types) across the range of conceivable macro environments. tightening toward a more stable global economy.
such as shifting preferences, not infection Inflation should eventually settle closer to central banks’
counts and restrictions. 200% target levels, allowing the longed-for “pivot” in interest
rates. Bid-ask spreads in real estate capital markets
A year ago, key uncertainties surrounding 150% will narrow, allowing activity to resume at an adjusted
our predictions for moving beyond the acute pricing level. The attraction of real estate as an asset
pandemic phase were around issues like new 100% class will endure, with variation around sectors, assets
COVID variants and booster deployment. As for and geographies.
today’s economic situation, key uncertainties 50%
include:
0% G.4
• How long will it take for inflation to come
under control? How high must interest rates Long-term inflation expectations remain subdued
go in the meantime? There have recently
-50%
Inflation-protected yields anticipating a deceleration of inflation
been signs that inflation is peaking, but such -100%
hopes could prove fleeting. Breakeven rate between nominal and inflation-protected risk-free rates
'20 '21 '22
• How severe an economic slowdown will be
3.5%
required to stabilize in inflation? Will the Americas Europe Asia Pacific
downturn be steep or shallow? Long or short
in duration? Source: MSCI Real Capital Analytics as of Q3 2022.
3.0%
• Longer term, will inflation become “endemic,” US: 2.3%
remaining sticky at a higher level than G.3 2.5%
observed in recent decades? Deep global REIT NAV discount
Implied inflation expectation
EPRA/NAREIT global index down sharply in September
There are reasons for optimism. Labor markets
(Over 10-year horizon)
2.0%
across developed economies are in almost Germany: 2.2%
universally good health. Some of the initial triggers Global RE securities premium / discount to NAV
1.5%
of this inflationary episode, such as supply chain
pressures, seem to be resolving. Household and
corporate balance sheets are reasonably healthy, 1.0%
although income statements are being hit by
higher debt service costs wherever borrowing Japan: 1.0%
costs are not fixed. The typical culprit for a 0.5%
prolonged economic downturn is a “balance
sheet recession,” as during the Global Financial
0.0%
Crisis, but the conditions for such a prolonged
slump do not appear to be met in most segments
of the global economy. Real estate fundamentals -0.5%
remain healthy and vacancy rates are low across
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many property sectors. Meanwhile, expectations
for subdued long-run inflation remain in place,
with long-run breakeven inflation rates implied by US Germany Japan
the market suggesting only a moderate increase
from prior levels (see Exhibit G.4). Source: EPRA/NAREIT, LaSalle Investment Management Securities. Discount
to NAV data to November 29, 2022. Source: Bloomberg. As of November 28, 2022.
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+ -
=
+
1 The math of spiking interest
rates is driving a repricing of
real estate
In a completely efficient market, real estate pricing should be closely
linked to that of the other asset classes that make up the broader
investable universe. Investors should receive similar ex ante returns
for similar risks, or else any “free lunches” will be arbitraged away. In
practice, private market real estate pricing tends to be impacted by
broader capital market shifts mainly when there are changes in the cost
of real estate debt, since the marginal buyer of income-producing real
estate is most often a leveraged buyer.
When debt costs rise, the market thins before favored sectors, although such adjustments are
price pressures are reflected in transactions. masked by lower price transparency in these
This tends to create a time lag between higher property types.
interest rates and declines in private equity
real estate pricing. In most markets globally, we This repricing has been labeled “mechanical”
are now feeling the impact of more expensive by some because it is a function of exogenous
real estate debt, which in many cases is no debt assumptions increasing in investors’
longer accretive to returns at current private spreadsheets. An alternative way to look at it
market valuations. is that it is mechanical because debt pricing is
a mechanism by which real estate is linked to
The math of debt costs and going-in yields the broader capital markets, through lenders’
is relentless. When the yield starting point “cost of funds.” Another such mechanism is the
is especially low in absolute terms, modest “denominator effect.” This involves comparing
increases in debt costs and yields as measured real-time values from public markets to lagging
in basis points mathematically translate into valuation-based assessments of private
big percentage changes in capital values. As market portfolios, causing some investors to yield starting point was exceptionally low and market
such, evidence of the most significant repricing conclude that they are suddenly overweight in interest rates have moved up much more markedly,
to date has been concentrated in the lowest- the unlisted assets compared to their target making the math that much more impactful.
yielding sectors, where transactions have held allocation. Either way, the downward direction
up most. This has surprised some observers of the pricing pressure is clear and it will likely Government policy also matters. As central banks
since these low-yielding property types are persist as long as the all-in cost of debt is seek to choke off inflation by tightening monetary
mostly the “winning” sectors of recent years dilutive to leveraged returns. policy, there is at least the reasonable expectation
and they continue to possess attractive growth that some of that inflation will be passed into rents
profiles. That some of the largest recent value Given the same inputs, the math works the and thus property cash flows. But when governments
declines may be occurring in the most sought- same way all over the world; but today those employ long-term borrowing to bail out energy
after property types, such as logistics and inputs to the math vary greatly, depending on consumers in the short term, as is necessary in
residential, might come as a shock after years local circumstances. In Japan, debt costs have Europe, interest rates are pushed up further and the
of banner outperformance, especially during the moved far less than in other parts of the world, impact on property values may be more detrimental.
pandemic. Even so, these property types remain as inflation remains subdued and the Bank of As the UK’s recent experience would suggest, credit
the strongest performers over longer trailing Japan continues to exercise yield curve control markets can react swiftly to reflect changes in
periods and values have also fallen in the less (see Exhibit G.5). By contrast, Europe’s real estate perceived debt sustainability.
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G.5
Spiking rates drive rapid tightening of financial conditions
Cost of capital rising sharply in most geographies
2
Nominal corporate bond yields
(January 2007-November 2022) The path of fundamentals
10%
will ultimately help determine
where values settle
9%
8%
7%
6%
Early in 2022, we framed the impact of rising inflation and interest
5%
rates on values as a race between debt costs and net operating income
(NOI) growth, as we anticipated that higher inflation would translate
4%
into higher rents in some sectors. Currently, it seems that debt costs
3%
are mostly “winning” the race. Ultimately, however, valuations are the
2%
result of the interaction between higher debt costs and the path of
1% real estate fundamentals, the prospects for which vary widely across
0% sectors and geographies.
Jan 22
Jan 13
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Jan 17
Jan 10
Jan 20
Jan 09
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Jan 11
Jan 15
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Jan 12
Jan 07
Tracing back real estate cash flows to their led inflation is relatively benign compared to
US C. Europe Singapore Japan United Kingdom Australia Canada drivers is to follow a chain of causation back to inflation from a supply shock, but the central
basic variables like population, GDP, industrial banks in these countries must still raise interest
Source: Bloomberg. As of November 30, 2022. production, consumer spending and employment. rates, either to manage their domestic economic
All of these interact with real estate factors, such situations or because their monetary policies are
as the balance of property supply and occupier linked to the US Federal Reserve (as in Hong Kong).
demand, to influence property cash flows. Secular Rising interest rates create clear risks to economic
megatrends and structural features like legal and growth, with housing markets already being
LOOKING AHEAD contractual constraints also matter. Going into impacted by higher mortgage rates.
2023, there is increased uncertainty in many
• The relentless math of higher interest rates to “averaging-in” with diversified timing of of these variables, especially the economic Europe’s employment picture is also solid, but in
will continue to weigh heavily on real estate entry points represent another way to cope ones, given the pace of economic expansion is addition to home-grown inflation, it is coping with
values, at least until interest rates stabilize with volatile and uncertain values. expected to be weaker or negative. This will have a severe, energy-driven supply shock caused
as inflation begins to subside. The bid- a cooling impact on property NOI growth, but by the Russia-Ukraine war. This, along with the
ask spread for private real estate should nuances remain given that the transmission of resulting cost-of-living crunch, places Europe’s
• The inputs to the math are not changing to
macroeconomic conditions to real estate is a economy in a weaker position than elsewhere.
eventually close and transactions will resume the same degree in every part of the world.
winding path. Its governments have been forced into crisis
in earnest at a rebased level. Wherever rate spikes are less intense, or
mode, devising legislation to absorb the burden
the prospects for rental growth are clearest,
Starting with the underlying economic of surging energy costs for households and
• In the meantime, investment styles that are transaction activity and prices have been businesses into government deficits and, if not
fundamentals, we are seeing a great deal of
less sensitive to volatility in values should less impacted. variation globally. In addition to the dimensions of paid for through increased taxes, higher national
be contemplated, such as floating-rate depth and duration, a key uncertainty surrounding debt. A recession is almost certainly already
lending with a comfortable cushion from • In addition to debt costs, investors should the coming downturn is how widespread it will underway across Europe.
lower loan-to-value ratios. Debt investment also consider the trajectory of cash flows, be. Europe faces especially severe challenges
can be attractive at times of uncertainty, which depend on economic fundamentals stemming from an energy price shock, with ripple Meanwhile, national economic factors continue to
as investors tilt toward contractually and real estate occupier market conditions. effects of unknown global scope. dominate in Japan and China. In Japan, inflation
certain income and away from an uncertain The differential prospects for real estate cash remains low compared to many other countries
upside. Portfolio aggregation strategies with flows are the subject of the next section. The dominant driver of inflation in the US, Canada and the Bank of Japan continues to keep interest
smaller asset sizes that lend themselves and Singapore is that their economies are robust rates close to zero and unchanged since 2016.
and operating close to full capacity. Demand- China is introducing easing measures to address
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its economic slowdown. We see these markets as drivers for certain assets, such as student housing, demand is in balance with supply, or even
“marching to their own drummers,” at least for now, which can benefit as people go back to school in better, when demand exceeds supply.
but they are not entirely immune to global forces. a weak job market. Some relatively cycle-resilient
property types, such as US medical office, single- The prospects for landlord pricing power are
Macroeconomic variation translates into variable family rental and self-storage are less likely to be brightest in logistics and various residential
demand for real estate, with layers of additional linked to underlying economic growth. strategies across the three regions we
influence from a range of property market factors. monitor, including US single-family rental and
For example, structural and secular factors, such As we explained in the 2022 ISA Mid-Year Update, European student housing. We also see an
as the growth of e-commerce and the rise of life real estate can be an effective inflation hedge, but the acute shortage of high-quality office space
sciences research, may prove strong enough to pass-through of inflation is uneven and incomplete. that is aligned with net zero carbon goals in
offset the drag from slower cyclical growth for Real estate performs better when and where many markets. We are least optimistic about
logistics and life science real estate, respectively. landlords have pricing power. In other words, inflation the office sector in the US and low-quality
There are also potentially countercyclical demand tends to flow through into rents when real estate malls almost anywhere.
Obstacles to rental growth, many of which
were not evident at previously low levels of
The path of fundamentals will depend heavily on local inflation, must be considered. For example,
despite a favorable supply/demand
and sectoral variation that unfolds in 2023 balance in many European residential
markets, regulations prevent rents from
Economic divergences matter: keeping pace. Likewise, inflation-linked
leases are hitting nominal indexation caps
that nobody ever expected to reach. The
Linked to global Supply-side energy Marching to their economic and property market conditions
rates cycle shock victims own drummers in North America, Europe and Asia Pacific
are covered in greater depth in the regional
sections of this ISA Outlook.
Additional challenge of energy National factors dominating
Mix of tight labor markets,
supply chain issues, global factors subsidy costs absorbed into global forces (at least for now) Logiport Huizhou
government debt China
UK Japan (yield curve control)
US
Continental Europe China (easing)
Canada
Singapore LOOKING AHEAD
Australia
• Close attention should be paid to evidence • Capital markets often paint with a broad
of worsening contagion from Europe to other brush. Smart investors can be more
global markets. Investors in Europe should discriminating and take advantage of the
Real estate fundamentals matter: be positioning for the buying opportunities “herd mentality” typical of the capital
that will eventually arise. markets. Investors should adopt a risk-
adjusted approach, such as the proprietary
S D D
Undersupply drives S Oversupply gives Structural obstacles • Investors should “look through” the current fair value model that LaSalle uses, to assess
landlord pricing power tenants upper hand to cash flow growth
economic uncertainty to evaluate which whether strong (or weak) rental growth
sectors and markets are likely to deliver expectations are already priced into asset
strong fundamentals despite a likely valuations.
Supply-constrained logistics US office Regulated residential
(mostly Europe)
downturn of unknown depth, duration and
Unregulated residential and living Commodity office in Europe scope. We remain reasonably bullish about
sub-sectors Long leases with no or the path for NOI in many logistics and
Low-quality malls
capped indexation
High quality and net zero carbon residential or residential-adjacent assets
office outside US across the globe.
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3 Beyond the sector chasm
– other factors gaining in
importance
In past editions of the Investment Strategy Annual, we made the case that
sector selection had become a powerful driver of portfolio performance.
The divides between property types have come to dominate the impact
of asset selection, quality and micro-location, which had been more
salient in the past. While sector divides remain, other factors are gaining
in relative importance.
Winning sectors like residential and logistics divides, investment traits beyond the property
have consistently posted stronger returns than type—like location, asset quality, covenant
pandemic-challenged sectors like retail or hotels strength and supply barriers—are thus likely to
(see Exhibit G.6). In both public and private rise in relative importance for investors’ portfolios
markets, the data show that the dispersion in 2023.
between the strongest and weakest performing
sectors is exceptionally wide. For example, a likely economic slowdown means
it will be necessary to get granular about land
While the supportive growth dynamics (“the constraints in favored sectors. This is definitely
Merryfield Row
path”) underlying the industrial and residential the case in industrial. We are most upbeat
about logistics markets that face barriers to new
San Diego, California
sectors remain in place globally, “the math” means
that rising debt costs are hitting capital values supply, such as urban submarkets in Europe,
hard in lower-yielding sectors. For example, the cities with greenbelt restrictions like Toronto
share prices of listed apartment companies in and markets with near-zero vacancy rates and Considerations around energy efficiency, net than others. Not all regions will move at the same
developed markets have fallen by 30% since the dwindling land supply like Sydney. Even in a softer zero carbon and other green credentials are fast pace in this arena, with Europe leading the way.
beginning of 2022 until November 25, 2022, versus macroeconomic environment, landlords are likely becoming the new frontier of the quality divide
to face upward pressure on rents in segments with within sectors. Both tenants and investors are Looking beyond basic sector labels also reveals
19% for the rest of the listed real estate market.
acute supply barriers. more focused on these traits than ever before. The potential sources of strength. Investors should keep
It is tempting to suggest that such value hits for improving transparency on sustainability matters, in mind that umbrella groupings like office, retail,
favored sectors may signal that sector differences Moreover, asset quality divides within sectors as highlighted in the JLL/LaSalle Global Real Estate industrial, residential and niche/alternative are far
are close to fully priced and that the performance are rapidly gaining in significance. This is in part Transparency Index (GRETI)1 suggests that the chasm from monolithic and are subject to unique market
gaps between property types will narrow going due to evolving expectations of the role of real is likely to widen between assets that deliver and conditions that vary by location and property
forward. Intuitively, this feels like it should be the estate. Working and shopping from home are those that do not. subtype. For example, research lab space, medical
case at some point; assuming an efficient market, often preferred, unless the in-person alternative is office buildings and more traditional office space
we should not expect to see a single “factor” (such sufficiently compelling for the end user. Tellingly, We expect the best and most “green” assets to should not be grouped under the same crude
as sector) drive persistent outperformance over the term “experiential retail” has recently been be easier to let and command higher rents, while umbrella term of office space. The supply and
many years. However, our proprietary fair value joined by “experiential office,” describing a also remaining more liquid over the long term. This demand fundamentals affecting each of these
analysis suggests that, for the most part, the sufficiently uplifting work environment to attract pattern is likely to affect all property types, but at have become highly polarized, especially in the US.
favored sectors retain strong relative value. employees out of their home offices and to foster the moment attention seems particularly focused We are much more confident in the prospects of
collaboration. If less aggregate office and retail on the office sector. As a result, we expect that the grocery-anchored retail in the US and Asia Pacific,
That said, we are also seeing widening gaps space are needed, it is reasonable to expect best office buildings—in terms of both location and or outlet malls in the UK, than we are of the broader
within sectors, some granular and others demand to be concentrated in the best properties building specifications—will perform more strongly retail markets in these geographies.
glaring, that we expect will also drive divergent and locations.
performance going forward. Because of these
1 JLL/LaSalle Global Real Estate Transparency Index (GRETI), July 2022
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G.6
Wide sectoral divergence has narrowed, at least in listed markets
4
MSCI Global Quarterly Property Index by sector
(Index December 2012 =100)
The balance of virtual and
400
400
350
350 Private,
Private,
Industrial
Industrial in-person interaction is close to
300
300
250
250
200
200
direct
direct RE
RE Allproperty
All property
Residential
Residential
a post-pandemic steady state
Office
Office
150
150 Hotels
Hotels
100
100 Retail
Retail
50
50 Most parts of the world have reached the ”living with COVID” phase of the
pandemic. One sign of this is that the language around vaccinations has
2021
Dec 2013
2012
Dec 2014
2020
2020
2022
Jun 2021
2013
2021
Dec 2012
Jun 2015
Dec 2015
Jun 2017
Dec 2017
Jun 2020
Dec 2020
Jun 2022
Jun 2016
Dec 2016
Jun 2018
Dec 2018
Jun 2019
Dec 2019
Jun 2013
Jun 2014
Dec 2021
changed. No longer do we talk about being “fully vaccinated” or not, but
Jun
Dec
Dec
Jun
Jun
Dec
Jun
about whether we are up-to-date on our seasonal boosters. Case counts
EPRA global composite return by sector
(Index December 2012 = 100) continue to ebb and flow, but the incidence of serious health outcomes
has fallen precipitously given widespread vaccine-based and natural
500
500
immunity in most populations.
400
400
Listed real
Listed real
300
300 estate
estate Industrial
Industrial
Apartments
Apartments As a result, COVID restrictions have been largely relativities that are in line with our predictions
200
200
Lodging
Lodgingand
andresorts
resorts eliminated around the world. In the US and on the “Future of Office” from the 2021 ISA.
100 Office
100 Office Europe, it is becoming rare to see anyone wearing One widely followed indicator of return
Retail
Retail
00 a mask. Barriers to travel, such as quarantines, to normalcy has been attempts to track
2012
2015
2015
2017
2017
2016
2016
2018
2018
2019
2019
2013
2013
2014
2014
2021
2021
2021
2015
2017
2020
2020
2020
2022
2022
2016
2018
2019
2013
2014
have been dropped even in places that once had companies’ return-to-office (RTO) policies.
Dec2012
Apr 2015
Dec2015
Apr 2017
Dec2017
Apr2016
Dec2016
Apr 2018
Dec2018
Apr2019
Dec2019
Apr 2013
Dec2013
Apr 2014
Dec2014
Apr 2021
Aug2021
Dec2021
Aug2015
Aug2017
Apr2020
Aug2020
Dec2020
Apr2022
Aug2022
Aug2016
Aug2018
Aug2019
Aug2013
Aug2014
strict constraints on entry, such as Hong Kong. In the US, these generally show a pattern of
Dec
Apr
Aug
Dec
Dec
Apr
Aug
Dec
Apr
Aug
Dec
Dec
Dec
Apr
Apr
Apr
Aug
Aug
Aug
Dec
Dec
Apr
Apr
Aug
Aug
Apr
Aug
Dec
Apr
Aug
The big exception to the removal of restrictions continued extension of remote and hybrid
is mainland China, where periods of normalcy are working arrangements as employees resist
interrupted by temporary lockdowns. But even in full RTO.
Source: MSCI, EPRA, LaSalle. Data through November 30, 2022. China, there are signs of change as public health
policies continue to evolve. • Play: In contrast to in-person work, in-
person play is booming almost universally.
We follow a wide range of data sources to Seated diner data from OpenTable point
evaluate how close to pre-pandemic normalcy to more people dining out than before the
LOOKING AHEAD we are. These include Google mobility figures, pandemic. Nightclubs are bustling across
office keycard entries, seated diners, airline the world. These trends are evident in public
enplanements and public transport ridership. transport usage too, which in many places
• Our analysis suggests that sector selection for offices in many markets already faces These data indicate that despite a lack of has recovered most strongly on weekends,
will continue to matter, but other asset and challenges from both an occupational and restrictions, the degree of reversion to pre- in contrast to weaker trends during the
strategy traits are rising in importance. We capital market perspective. pandemic norms is incomplete and uneven by business week. Leisure travel has also
expect quality divides to widen everywhere activity and location. We divide our observations recovered robustly.
as the balance of power tips in favor of • The uneven impact of a return to physical into work, play and live:
tenants and structural trends to accelerate offices in the “living with COVID” phase • Live: It was feared during the pandemic
the obsolescence of less modern and less of the pandemic shows that investors • Work: Office attendance remains significantly that work-from-home would mean “work
green assets. should avoid projecting their own country’s lower than pre-pandemic levels in many anywhere/live anywhere.” Evidence for
view of a sector too far away from geographies, especially the US, where weekly this was out-migration from city center
• While rising sustainability and net zero their home market. For example, office total keycard entries to office buildings apartments into suburban or even rural
carbon pressures will drive a divide between fundamentals remain relatively healthy in are only 48% of pre-pandemic levels as locations. More recently, a return of residents
the best and the rest across all sectors, we Asia and Continental Europe, while they are of November 21, 2022. Office usage is to cities has been observed, as some people
meaningfully higher in Europe and quite have moved back to vibrant locations for
expect the dispersion to be widest in the particularly weak in the US.
close to pre-COVID levels in much of Asia, opportunities to work and play. The new
office sector. This is because the outlook
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G.7
Virtual vs. in-person balance close to a post-pandemic steady state
Improvement in office attendence has mostly stalled
Global workplace mobility
(Time spent relative to January 3 to February 6, 2020 baseline; six-week moving average)
0
France
% Change from baseline (trailing 30 days)
-10
Japan
-20
United States
United Kingdom
-30
-40
Steady state?
Gradual
-50 improvement
with start/stop
Reopening
-60
Initial Summer Alpha Delta Summer Omicron Summer
-70 lockdowns holidays holidays holidays
Jan-21
Feb-21
Apr-21
May-21
Sep-21
Oct-21
Nov-21
Dec-21
Jan-22
Feb-22
Apr-22
May-22
Sep-22
Apr-20
Aug-20
May-20
Sep-20
Oct-20
Jun-20
Nov-20
Dec-20
Aug-21
Mar-21
Aug-22
Jun-21
Jul-21
Mar-22
Jun-22
Jul-22
Mar-20
Jul-20
Source: Google Mobility data to October 15, 2022.
pattern might be termed “work anywhere/ of gradual improvement interrupted by variant-
live somewhere,” with urban places that offer related setbacks, but leveled off as of mid-2022, LOOKING AHEAD
a strong quality of life, a good amenity base as shown in Exhibit G.7. Given that COVID-related
and a sense of place remaining resilient. City restrictions are mostly gone, further normalization • Further large changes in the balance • While the balance of in-person and virtual
living might not be everyone’s ideal, but it has in the balance of in-person and virtual modalities between in-person and virtual interaction modalities may have reached something
come back into favor for part of the population. will have to rely on changes in company policy and are probably unlikely. This does not preclude close to a steady state, occupiers are in the
Meanwhile in Asia, home to dense cities that the possible influence of a recession on workplace any cyclical changes to discretionary early days of reconfiguring workplaces to
integrate live, work and play into mixed-use culture. Exceptions include international travel in
spending that respond to the economic match the new “living with COVID” world.
settings, it never really fell out of favor. Asia Pacific and cross-border migration, which still
situation, such as a potential reduction in Companies are likely to focus more on
have robust intrinsic recovery potential.
Perhaps the most important observation about the travel and going out because of squeezed collaborative spaces and less on rows of
balance of in-person and virtual interaction today real incomes. desks, with implications for space demand.
is that it appears to have reached a steady state, The key questions have shifted from the
at least for now. Dining out seems to be stable at • It is probably wishful thinking to expect amount of in-person work, to the precise
a high level. Office usage indicators like workplace further large gains in office attendance amount and type of space needed to
mobility and keycard entries, however, are stuck anywhere in the world. This is most significant facilitate interaction and collaboration.
at a more moderate, if globally variable, level. for the US, where office use is lowest. That
They had been characterized by a broad trend said, a weakening of the labor market could tip
the balance of power away from employees as
employers mandate a return.
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5 Moving from climate
awareness to planning
and action
Different parts of the world are moving at different speeds regarding
awareness, regulation, market reaction and policy action on climate change
and real estate. Depending on the jurisdiction, the focus varies from the
narrower goal of hardening against physical risk, to full decarbonization.
European countries are moving at different speeds, but all in the same
direction. Policies in US states are diverging based on political dynamics.
In Asia Pacific, the trend is mixed. Despite this variation, the events of 2022
have dramatically reinforced the need for action on climate change, both
at the macro level of governments and industry and at the micro level of
property-specific resilience and futureproofing. Investors should continue
to plan and take action to adapt portfolios to evolving climate-related risks. Not all of 2022’s dramatic events were meteorological;
some were geopolitical. The shutdown of natural gas
Weather over the past year has almost certainly Environmental Information. Meanwhile, Japan and flows from Russia to Europe drove a severe spike in
caused the pile of catastrophic insurance losses to the US recorded their second- and third-hottest energy prices in that region. European commercial
keep mounting (see Exhibit G.8). Hurricane Ian was summers, respectively. Knock-on economic effects tenants have begun to put pressure on landlords to
included the pausing of railway service in Britain address increasing energy expenses passed through
the fifth-strongest hurricane to make landfall in the
and the disruption of goods traffic on rivers in to them under net leases, asking them to cap service
United States and may prove to be the costliest
charges, defer contractual rent increases and improve
in history. Severe damage, including complete Europe and China due to low water levels.
the buildings’ energy efficiency.
destruction, has occurred to real estate in the
storm’s path. Even properties that were relatively Events such as these reinforce how critical it is that
Occupiers in Europe now actively shop for space looking
undisturbed were left cut off from road access, investors evaluate the extent to which physical for an acceptable total occupancy cost, including both
climate risk hazards may directly impact real estate rent and energy costs, putting direct downward pressure
power, internet, water and even mobile service due
portfolios and “harden” buildings to make them on rents for energy-inefficient buildings. This exposes
to damaged infrastructure.
resilient to climate change. Unfortunately, the range landlords to energy costs as if the lease contracts were
A forceful hurricane season in 2022 was of tools to measure and predict climate events gross leases, no matter what the lease may actually say.
preceded by a sweltering summer in the Northern remains immature.2 Despite inconsistencies in Efficiency improvements, electrification and on-site
Hemisphere. Europe and China recorded their the data, there is no time to waste. It is critical to power generation are cornerstones of decarbonization
hottest-ever summers since recordkeeping began move beyond data collection and dashboarding, strategies. They also help ensure asset competitiveness
in 1880, according to NOAA’s National Centers for to incorporating climate risk into investment and and energy security at the building level.
portfolio decisions.
The energy crisis has caused the merging of the various
rationales for reducing the carbon intensity of real
2 When we reviewed multiple data providers, we found considerable inconsistency in how metrics are defined and wide variation in risk
estate, especially in Europe. Motivations for reducing
scores for the same hazard at the same property. Our recent report, “How to Choose, Use and Better Understand Climate Risk Analytics,”
researched and written in partnership with the Urban Land Institute (ULI), is an excellent overview of the challenges faced by first-time carbon emissions include reputation-building, marketing,
consumers of climate data. The paper outlines physical climate risk basics, identifies differences between data providers to be aware of regulatory compliance, meeting tenant and investor
and raises a call to action to standardize the outputs in ways that are most meaningful and useful for real estate, with transparency that climate pledges and doing the right thing to reduce
enables apples-to-apples comparisons across models. global warming. In a moment of crisis, these rationales
have converged with the basic objective of delivering real
estate that is affordable to its users.
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G.8
Evidence mounting of accelerating costs from climate change
Global insured natural catastrophe losses by year
Weather-related, earthquake/tsunami and man-made catastrophes; losses before
2021 are adjusted into 2021 USD
180 H2 2022
likely to set
Total insured loss, USD billions
160 record due to
140 Hurricane Ian
120
100
80
60
40
20
0
1988
1982
1992
1984
1994
1980
1990
2010
2020
1986
1996
2006
2016
1998
2008
2018
2002
2012
1H 2022
2004
2014
2000
Total Insured Catastrophic Loss Five-year Trailing Average
Source: Swiss Re Institute. Data to H1 2022. Latest available as of September 26, 2022.
LOOKING AHEAD
• The European energy crisis shows how renewables may, in certain situations and
quickly energy efficiency can move from especially for existing portfolio assets in
being “nice to have” to an economic Europe, offer one of the most attractive
imperative. The rest of the world is not in the risk-adjusted returns on capital available
same situation as Europe, but its experience today.
shows that conditions can change quickly
and it is better to prepare for the future than • The transition to a decarbonized world also
to be simply reactive. brings nonphysical transition risks that tend
to be specific to local markets. These include
• Physical climate risk must be managed at changes in insurance availability and costs,
two levels: at the portfolio level, through regulations, taxes, incentives, and changes in
assessment of exposure concentrations and tenant and capital market demand.
consideration of how climate risk informs
overall portfolio construction strategies; • For a deeper dive on the energy transition
and at the property level, through evaluating and how it relates to real estate strategies,
both existing and potential new hardening have a look at LaSalle’s November 2022
strategies to be more resilient against report “Decarbonization and the Evolution
particular hazards. to Net Zero Carbon Real estate.”
• Incremental investments in hardening
against physical climate change, increasing
energy efficiency and installing on-site
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Asia Pacific
Relative strength and absolute diversity
• Asia Pacific contains • Real estate capital market The outlook for major Asia Pacific economies AP.1). China has implemented monetary easing
tremendous diversity in activity in the region has is relatively benign in the global context. to support the economic recovery and offset
The developed economies of the region are some of the negative impacts of its COVID-
the extent to which global remained relatively resilient, experiencing inflation rates running below those Zero policy. Monetary easing, combined
economic trends are being owing to the dominance of of the West, although these economies are with various supportive home purchase
felt locally. Its two largest intra-regional and domestic not immune to tightening financial conditions policies, could be the catalyst for the housing
economies, Japan and China, capital flows. and slowing global economic growth. The odds market in China to bottom. The pace of the
of a recession in the next twelve months are housing market recovery will depend on the
are seeing stable or loosening increasing, but are still below those of other government’s efforts to ensure the delivery of
monetary policies as the rest of • Post-pandemic changes in ways regions, especially Europe. However, if global unfinished properties by defaulted developers
the world tightens. Meanwhile, of working and living are modest inflation persists longer than anticipated, central and the direction of the COVID-Zero policy.
monetary conditions in the banks would need to hold interest rates higher for Public health restrictions in China are likely
compared to other parts of longer and it could take either a severe recession to fluctuate under the influence of case
smaller economies in the region the world, which suggests that or an exogenous shock to bring down inflation. resurgences. While the timing of China fully
closely resemble the dynamics the persistent sector divides Under this scenario, the relative economic unwinding the policy is uncertain, the end of
in Western nations. observed elsewhere are likely to strength of Asia Pacific could diminish. COVID-Zero, if and when it takes place, would
bring a welcome upside to regional and global
be less severe in Asia Pacific. Asia Pacific is remarkable in that the demand. Furthermore, signals from the 20th
• Key uncertainties include policymakers of its two largest economies, National Congress of the Communist Party
whether the Bank of Japan can China and Japan, are implementing monetary that concluded on October 22, 2022 pointed
policies that are distinctively different from
continue to keep long-yields those of other major central banks (Exhibit
to a stabilizing domestic environment and
low and the prospects for China
ending its COVID-Zero regime.
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