Trends in Profit-Yielding Real Estate Returns in Major Cities

A glance to the future

Current market conditions suggest that real estate investments will continue to perform well in the foreseeable future. The following economic and structural factors are expected to fuel investor appetite for real estate and drive returns:

  • Low interest rates: Real interest rates in most developed markets are negative and have been for some time. This has had a profound impact on every asset class, including real estate. Investors of all types have been forced to look outside of traditional sources in their search for yield. Many investors have turned to real-estate as an alternative to investment grade fixed income investments that pay lower yields. While the Federal Reserve has begun raising interest rates in the U.S., rates remain near historic lows and will likely continue to drive flows into field in the future.
  • Low unemployment: The unemployment rates in most developed countries have now recovered to pre-crisis lows. This greater level employment has caused an increased demand for the market, and in particular in major cities. This demand will likely to continue to fuel returns for the foreseeable future.
  • Low inflation: In addition to low interest rates, a persistently low level of inflation over the past decade has meant that high nominal yields paid on property investments have translated into real spending power. Additionally, many investors view it as an inflation hedge, since rent can be raised if prices rise.
  • Population growth: Because populations continue to grow every year, investment in new projects must be made in order to supply larger future populations. However, new construction often fails to meet the needs of growing populations, leading to rising real estate prices and increased rent. Thus, population growth provides a consistent level of support for investments.
  • Improving consumer balance sheets: Leading up to and following the 2008 global financial crisis, consumers in most Western economies were extremely overleveraged. However, consumers have now regained financial health. Strong consumer balance sheets will allow consumers to obtain the credit needed to purchase properties, generating additional demand and causing prices to rise.
  • Regulations: Real estate investments enjoy some of the lowest reporting requirements of any asset classes. For example, international investors hoping to open a bank account or purchases stocks and bonds in the U.S. must fulfill extensive “Know Your Client” (KYC) and anti-money laundering requirements prior to doing so. To complete these requirements, the financial firm that the client is opening an account with must verify their identity and ensure that all incoming money is originated from a legitimate source. This same investor can purchase a condominium in New York City without any of these requirements. For this reason, real estate in major cities has become an attractive investment for foreign investors hoping to discretely move money away from their home countries. The most notorious example of this practice is the insatiable appetite for international real estate of the Chinese upper and middle class, members of which have poured billions of dollars into the market in the U.S., the U.K., and Australia in order to circumvent the Chinese government’s strict capital controls. This behavior is almost certain to continue in the future, increasing demand for investments
  • Increased retirement age: Because of social security and other governmental budget shortfalls, many countries are considering raising the legal retirement ages. This will increase the size of the labor force and prevent older citizens from leaving major cities, bolstering demand for urban properties.
  • Urbanization: The populations of most major cities are growing at higher rates than those of their overall countries. This trend is likely to continue as millennials abandon smaller towns in pursuit of economic opportunities in urban hubs. New developments are often unable to keep up with this growth. Rent and prices must rise in order to offset this supply shortage.
  • Co-working products: Co-working products have created a new use for real estate that appeals to a wider audience than traditional office leases. This has unlocked a new and growing source of demand that must compete against conventional sources for a limited supply. As this trend continues, real estate returns will be bolstered by this additional demand.