Outlook 2025
Real estate as an asset class has historically been highly sensitive to interest rates and is expected to be one of the sectors that benefits most from lower rates over the next 12 to 24 months. Global real estate returns also correlate strongly with global growth, though certain subsectors within real estate are less sensitive to macroeconomic volatility. Overall, the combination of lower interest rates and healthy global growth is likely to be particularly powerful for this asset class. Higher capitalisation (cap) rates and yield-on-costs for recently completed buildings – or still healthy levered returns in Japan – have created attractive entry points for new investments.
Historical data from Preqin highlights that those funds that deployed capital following periods of elevated volatility, including in the aftermath of the global financial crisis or early 1990s recession, generated the highest internal rates of return (IRRs) and equity multiples emerging from these downswings (Figure 1). A similar returns pattern is expected for new fund vintages emerging from this cycle. For example, rising stress levels – particularly in the US and Europe –are creating opportunities to acquire new buildings and sites at discounted prices from developers struggling with refinancing risks, high construction costs, and lower sales prices. The sharp pullback in construction that has been seen across many markets also minimises the downside risks for valuations as future oversupply concerns recede.
Source: Preqin (November 2024).
Overall, we think the strongest risk-adjusted returns remain focused on sectors with solid structural drivers and supply-demand imbalances, including residential, logistics, premium offices, and alternative property types. Gaining access to these asset classes requires sector specialist skills and knowledge, including asset and submarket selection, which is underpinning demand for accessing opportunities through specialist operating platforms from many investors. Often, sector specialist operating platforms are better connected to their respective markets, able to source off-market deals, work through planning regimes, and deliver developments that are catered to local tenants, boosting overall returns and equity multiples. The need for specialist skills through the investment life cycle of assets has become more evident as virtually all real estate sectors have become more operationally intensive and, therefore, the importance of these skills in maximising asset values through operational gains has become clearer.
Even in the office sector, we think that more operational expertise is needed to drive value for occupiers and investors relative to the pre-COVID-19 environment. Platforms that can fulfil highly differentiated tenant needs and evolving capital expenditure (capex) requirements driven by increasing environmental, social, and governance (ESG) regulations alongside decarbonisation and digitalisation trends will be better placed to generate alpha for investors.
Sector specialist operating platforms are better connected to their respective markets, able to source off-market deals, work through planning regimes, and deliver developments that are catered to local tenants, boosting overall returns and equity multiples.”
Residential’s linkages with inflation (at least in less regulated markets) and resilient cash flows through cycles underpin the sector’s investment case against traditional property sectors that are more exposed to macroeconomic volatility and jobs growth. Looking at fundamentals, recent household formation rates (as a proxy for demand) have remained high relative to weakening housing starts (Australia) or are following an extended period of undersupply since 2008 (UK and US), which is keeping prices elevated for potential homeowners. In many cities, high migration and strong population growth continue to prop up demand, with hybrid working also adding to the equation given the preference for larger living spaces, though this trend may have peaked as hiring slows.
Demographics is a key factor driving specific demand for more affordable housing types across cities and age groups. For younger, more mobile populations and middle-income households, elevated prices and stretched homeownership affordability metrics mean that rental housing is the cheapest living option for many. For key workers in the US and retirees in Australia, manufactured homes and land lease communities also remain more affordable residential alternatives, which is fuelling demand aided by strong population growth of these age groups.
In the office market, prime rents are rising with tenant demand concentrated on high-quality, transport-enabled assets in central locations, particularly in Europe and parts of the Asia-Pacific region. Despite broader challenges for the sector, pre-leasing activity is lifting with occupiers committing to new or refurbished offices well ahead of completion amid strong competition for high-quality space. For investors, office pricing appears to have fallen well below replacement costs, and higher cap rates are creating good entry points for new investment. Specific asset and submarket strategies will be key to future performance, with returns remaining tight for new developments, at least in the near term.
At this stage of the cycle, we continue to have a general preference for value-added office strategies on a risk-adjusted basis (expected returns versus target rates), though this will gradually shift as new supply dries up and financing costs fall back. Construction will make more sense as prime office rents rise relative to construction costs, supporting higher development margins, aided by increasing risk appetite. A stronger global demand recovery could see development activity lift more quickly than expected as existing premium office supply is absorbed by tenants.
In the logistics sector, higher cap rates in many developed markets, steady rental growth projections, and low capex requirements underpin returns for the asset class, including value-added strategies where in-place rents remain well below market. Following COVID-19-related surges, demand and growth have largely normalised and industrial starts have fallen sharply, with rents coming under pressure in selective coastal markets that are exposed to China-US trade tensions, such as Los Angeles and Shanghai, and pockets of oversupply impacting other submarkets across Asia. Occupier demand and rental growth are set to lift again over the medium term as rising inflation-adjusted incomes support in-store retail spending and online sales in volume terms (which is the most important metric for demand), and occupiers compete for a reduced supply of new facilities coming on stream over the next two to three years.
Sources: Green Street, Jones Lang LaSalle, Property Management Association (October 2024).
Any lift in new and existing home sales driven by falling mortgage rates, which boosts spending for durable goods (e.g. furniture, electronics), would provide a further boost for warehousing and self-storage space, alongside migration trends. On the flip side, ongoing trade disruptions are set to impact global supply chains further as more governments look to protect domestic manufacturing and jobs through tariffs and subsidies. Southeast Asia, Mexico, and southern US markets will be key beneficiaries of supply-chain evolution, further aided by China’s rising unit labour costs, which is impacting manufacturing margins. Longer term, an estimated 1 billion+ square metres of new industrial space across the Asia-Pacific region will be needed to service incremental growth in trade and manufacturing, with additional opportunities to modernise the region’s capital stock towards US per capita levels over the coming decade.
David Roberts
Head of Real Estate Strategy
