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GLOBAL OUTLOOK
Grosvenors research perspective on world real estate markets
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View from the US: The recovery will continue, but patience is still required
The turnabout in sentiment has been impressive. Just a few months ago, a potentially devastating European recession loomed, and key sectors of the economy were failing to gain traction. Today, by contrast, we find ourselves in the midst of better-than-expected growth, supported by a broad uptick in economic indicators. Our view is that this surge in the recovery does indeed have substance, but various sources of weakness remain. As a result, we think that the recovery will continue at a moderate clip, but more robust growth will remain elusive in the near-term. The basis of our optimism lies in employment growth. Thus far, we have remained sceptical of embracing any recovery until a pattern of substantive job growth commenced. We have been pleasantly surprised over the last few months. The US economy added over 200,000 jobs in each of the last three months through February, leading to a substantive decline in the unemployment rate. Other employment indicators affirm the positive trends: declining new claims for unemployment insurance, increased number of job openings, and rising intentions of small business to hire.
US disposable income growth
8%
Nevertheless, the recovery will be hampered by a number of factors. One of these is the impact from Europe, which is expected to affect growth particularly in the first half of the year. Further Federal, state, and local government fiscal austerity measures and the expiration of certain stimulus programs will also have a negative impact on domestic demand. In addition to these headwinds, we remain sceptical of the ability of two major sectors of the US economy, housing and consumption, to provide enough fuel for a really robust recovery. Within the housing sector, the for-sale single-family market has clearly bottomed, but prices and new starts will only recover gently over the year ahead. Fortunately, a vibrant rental market is ameliorating housings drag on overall economic growth and, in fact, is becoming a good source of construction jobs for the economy. Perhaps the most important reason for caution is the outlook for consumption, nearly 70% of the economy. The US consumer continues to de-lever, and the savings rate remains elevated. We think it will take American consumers at least until 2015 to return to the long-term average in their use of leverage. Furthermore, not helping matters has been unremarkable income growth. The recent ascent in oil prices provides another challenge, and is a significant wild card to derail growth in 2012. In short, while the US recovery seems to be back on track, we think it will fail to meet the more optimistic expectations. Stronger growth is unlikely to begin until the consumer is unleashed and single-family housing accelerates. This said, we do think that the US will be a source of economic stability in a world of uncertainty.
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easing concerns over the euro zone sovereign debt crisis, better-than-expected data from the US and a soft landing scenario for China. While external uncertainties remain, prospects for trade will slowly improve as global demand recovers. The drag on economic growth will lessen as supply chain disruption to production eases together with a reduction in imported fuel substitutes for nuclear power. The positive growth momentum in production and machinery orders received for exports underscores a better picture for Japans trade sector this year. Back-loading of reconstruction stimulus is taking place. Although JPY21 trillion has been earmarked to rebuild the areas devastated by the March disaster, the boost to growth has so far been limited by delays in disbursement and a shortage of construction labor supply in the affected areas. Thus, public investment in Q4 fell by 9.5% on top of a 6.2% decline the quarter before, after posting a 28.9% rise in Q2 immediately after the earthquake. This back-loading of reconstruction spending this year will substantially boost growth, cementing an above-trend cyclical recovery even if the drag from weak external demand persists. Policy tailwinds to strengthen growth prospects further. A recurring feature of Japans economic performance over the years is that private sector demand has stayed relatively sluggish, even with zero interest rate policy and more than enough banking system liquidity. However, the recent decision by the Bank of Japan (BOJ) to increase Japanese Government Bond (JGB) purchases in the Asset Purchase Program (APP) and pursue a more binding 1% inflation target at the same time is a significant shift in policy with very positive growth implications. In February, the BOJ announced plans to increase the APP to JPY65 trillion (from JPY55 trillion) via JGB purchases to be completed by the end of the year. The central bank has raised the ceiling on its APP every four months on average since October 2010. The latest initiative to spend JPY10 trillion solely on JGB purchases will more than double this years target from JPY9 trillion to JPY19 trillion. At the same time, the BOJ also announced an explicit inflation goal of 1% . While the policy change was not directed at financing the fiscal deficit, it appears that future additional fiscal spending is more likely to be financed by the BOJ. Effectively this is initiating debt monetisation. The direct impact of such a move going forward is an increase in monetary base (and aggregate demand) finally leading to a rise in price levels and a decrease in the value of the JPY. If the BOJ continues to aggressively increase the APP in the coming months, the combination of rising inflation (in Japans case, the timing depends on how sticky the deflationary mindset is) and yen
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Macro cyclical upturn: The projected improvement in economic growth is likely to lead to a more robust and sustained rebound in domestic demand conditions, providing a positive feedback loop between business expansion and job market conditions and benefitting office and residential rents which are both at cyclically low levels. On top of the step up in rents, the coupling of BOJ debt purchase and inflation target will also lead to a more concrete improvement in investment demand steming from improving financial conditions, increasing asset prices and economic activity. Debt/equity liquidity improvement: Bank lending to the real estate sector has been steadily growing, corroborating the message of the December BOJ Tankan Survey readings which show ongoing improvement in actual lending attitudes to the real estate sector (Chart 2). The mix of uncertain economic conditions in the US and euro-area and full valuation in many emerging Asian markets has also led to increasing interest in the core Tokyo market, where relatively attractive pricing and yield spreads exist. The improving liquidity picture will lead to a recompression of cap rates in the coming quarters, following the stall due to the March earthquake. The return of J-REITS to the market in the past year - as shown by increasing acquisition and disposal activity - will also help supplement the upturn.
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depreciation will provide a virtuous circle of economic growth (through stimulating spending, as debt burden is transferred from debtors to creditors, and exports) and financial asset price rises leading to an increase in nominal real estate values and potential gains in equities. Growth leading to sustained and strong real estate recovery. The Tokyo property market is on the cusp of a steadily strengthening recovery. While real estate prices have increased since the global financial crisis, a full-fledged upturn has yet to occur due to a confluence of dampening factors: (1) highly uneven economic performance as previously described; (2) refinancing workouts, the pull out of foreign capital and the collapse of the CMBS market holding back investment demand, and; (3) supply/demand imbalance especially in the Grade B office and mass residential sectors holding down rents. From a cyclical perspective 2012 provides a unique and attractive window of opportunity to enter the Tokyo real estate market. The key drivers of the real estate upturn will be:
Chart 3: Grade B office rents
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Demographic boost to housing: Despite an aging population, there remains a strong case for investment in the Tokyo housing market. Rising migration into Tokyo, children of the baby boomers (who make up around 15% of the population) with the financial capacity to purchase their first home, low financing costs and tax breaks will combine to provide a demographic sweet-spot for the housing market in the coming years. The stars are aligned to provide good returns in the Tokyo real estate market. The time to enter the market is now. Price and rental levels are still near their lowest levels leading up to a projected cyclical recovery (Chart 3). Improving liquidity coupled with policy and demographic induced demand will first trigger and then further strengthen and deepen the duration of the upturn, providing an attractive window of opportunity to invest, achieving strong income and capital returns.
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Aneta Wiak Britain & Ireland T +44 (0)20 7312 6199 E aneta.wiak@grosvenor.com
This edition of the Global Outlook, along with all previous articles can be found on the Latest Research and the Research Archive sections of our website www.grosvenor.com/research.
This document is for general informative purposes only. The information has been compiled from sources believed to be reliable however its accuracy and completeness are not guaranteed. The opinions expressed are those of the Research Department of Grosvenor Group Limited ("Grosvenor") at this date and are subject to change without notice. Reliance should not be placed on the information, forecasts and opinions set out herein for any investment purposes and none of Grosvenor, its affiliates, officers, employees or agents accepts any liability arising from such use or any other use, or for the contents of this document. This document is intended for professional and non-private investors only. No part of this publication may be reproduced in any form without the prior written permission of Grosvenor.