Global gateway markets remain consistent

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Global gateway markets have received approximately 30% of all capital through the current real estate cycle1. Our analysis suggests that the proportion of capital heading to gateway markets has remained surprisingly consistent as transaction volumes have picked up.

Globally, at least, there has not been a rotation away from gateways as pricing has been driven higher; however, this masks significant differences across regions.

EY - Total global volume: gateway vs. non-gateway mkts (US$ B)

In Europe, gateway markets have become less prominent (not helped by underwhelming market fundamentals in this cycle) – mature European and US investors dominated investment flows, and they have led a move away from gateway markets as they look for better opportunities across the continent.

The Asia-Pacific region has had a different experience: gateway markets have risen in prominence as the cycle has matured. Cross-border investors are relatively more important; Sydney and Melbourne have been especially large recipients of cross-border capital from China, Singapore, the US, Canada and Hong Kong.

In the US approximately 40% of capital deployed since 2010 has been invested in five gateway markets. Gateways have continued to accrue a similar proportion of all investment as overall investment volumes have risen.

EY - Gateway as % of regional transaction volumes

Cross-border investors account for about 15%2 of the overall market and have remained particularly focused on the US gateway markets; 57%3 of cross-border capital invested in the US since January 2015 has gone to gateway markets led by capital from Canada, Singapore, China, Qatar, Germany and Norway.

Investment activity has been helped by recent US FIRPTA tax law changes that are encouraging foreign investment in US real estate by investors who can benefit from the changes.

 
  • Case study: London pricing

    Yield premiums between London and regional UK markets average 124 bps but have fluctuated significantly over the last 25 years. But, since 2010, London has been a clear favorite. Investors have been prepared to pay a relative premium to access the UK capital — by as much as 200bps in 2013 — even as regional transaction volumes have picked up and yields nationally have declined.

    EY - London vs. Regional UK cities

     

    Today, that premium has been almost completely eroded. From a historic analysis of relative pricing, London looks fairly priced in comparison to regional UK markets.

    Rental growth through this cycle has helped justify pricing, but with London rents at or near historic highs, vacancy ticking up marginally from record lows, supply set to pick up, and Brexit raising questions over future demand, investors are pricing in a more neutral London vs. regional stance.

    Of course, none of this takes away from the fact that even if pricing across asset classes is not unfavorable to real estate, absolute market pricing remains high by historic standards.

  • What is next for gateway markets?

    Historically, stronger net operating income growth in gateway markets — helped by late cycle rental spikes — has been sufficient to offset the higher prices that prevail in these markets.

    Structural drivers
    • Vibrant locales
    • Centers of learning
    • Extensive networks
    • Transparent market
    • Diverse real estate markets
    • Deep talent pools
    • Diversified economies
    • World-class facilities
    • Hubs of entrepreneurism
    • Large markets
    • Centers of the global economy
    • World class transportation hubs

    Outperformance is often driven by late cycle spikes. However, rental growth has been less pronounced across many gateway markets in this cycle.

    European markets in particular have been laggards with rents often underperforming longer-term growth trends. This has made relative yield premiums harder to underwrite.

    The structural drivers that make gateway markets irresistible to many remain in place and will no doubt continue to appeal to both domestic and overseas buyers. But even in gateway markets such as London where rent spikes have occurred, from a relative pricing perspective, the premium between gateway and regional markets is now close to longer-term averages. From a gateway/non-gateway perspective pricing today is more about absolute levels given that relativities are broadly in line with historic norms.

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  • Case study: Chinese capital going beyond gateways

    The breadth and depth of capital sources in China make for a complex investment picture. There are myriad groups that have different investment requirements and experience in the real estate sector. Very often, consortiums pool resources with different partners who bring capital in addition to a range of skills and experience.

    As a result, many of these consortiums have an abundance of real estate knowledge and have already made initial investments in global gateway markets. They are also comfortable with taking on investment risk in non-gateway markets.

    One noteworthy group is the Chinese developers who are actively diversifying away from mainland China Tier 1 cities and are looking to apply their extensive development experience globally. Key drivers behind the diverse destinations of Chinese cross-border capital include:

    • New groups pooling capital.
    • Diverse capital sources resulting in diverse requirements.
    • Developers diversifying away from Tier 1 Chinese cities.

    EY - China cross-border capital flows: global (US$ B)

    RCA data highlights just how these cross-border investors have moved beyond gateway markets in 2015 and through 2016 to date. In 2011 global gateway markets received 79% of cross-border Chinese capital.

    But, by 2015, gateway markets received only 46% of cross-border investments from Chinese investors. Year to date through October 2016, there has been a slight uptick with gateway markets accounting for 50% of cross-border volume.

    Maturity and familiarity are driving broader investment mandates

    The diverse pool of Chinese investors has a wide range of requirements around returns, holding periods, asset types, etc. Many have made investments overseas, often initially in gateway markets.

    Anecdotally, many Chinese investors consider smaller, Tier 2 markets, such as Portland, Seattle, Miami and Chicago, to offer better value with more attractive yields. Asset class diversification is also evident: office and residential condos have been prevalent to date, but Chinese investors are increasingly looking at senior living, student housing and multifamily.

    Investment activity in 2016 has mirrored the trend seen in 2015 of a more even split between gateway and non-gateway markets. While relative pricing and investment prospects will continue to influence the direction of capital in the short term, increasing maturity and familiarity with overseas investing is allowing many important sources of capital to broaden their investment mandates to the benefit of non-gateway markets.

1 “Cross Border Capital Tracker,” Real Capital Analytics, accessed 31 October 2016.
2 “Investor Composition,” Real Capital Analytics, accessed, 31 October 2016.
3 “Cross Border Capital Tracker,” Real Capital Analytics, accessed 31 October 2016.

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