Global outlook

A Crisis Brings Opportunity

Today’s investment opportunities span a wide range of categories, including capitalizing on favorable occupier momentum linked to accelerated changes in how real estate is used, investing in assets that require some short-term repositioning, and finding value in parts of the market that have undergone a long-term correction.

Global Investment Opportunities

Dr. Peter Hayes

Global Head of Investment Research, PGIM Real Estate

2021

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Out of a crisis comes opportunity. Given our assessment of the outlook for global and regional estate markets, we identify the following opportunities as being among the most attractive on a risk-adjusted basis over the next 12 months:

STRATEGIC ALLOCATION RECOMMENDATIONS

EXPLORE FINDINGS

Asia Pacific

Grade A Offices

Hotels

Logistics and Cold Storage

China Deleveraging

Residential Sector

Europe

Logistics and Cold Storage

Distressed Retail

Modern Living Space

Grade A Offices

Americas

Grade A Offices

Urban Apartments

Last Mile Retail

Accelerated change

Ongoing Tailwinds

Short-term repositioning

Long-term Correction

Favorable momentum prior to the COVID-19 global pandemic has been positively affected by behavioral change — related notably to a rise in online retailing, supply chain expansion and increased demand for cold storage.

Favorable momentum prior to the pandemic has remained relatively unchanged — for example, by reflecting structural shifts in living-sector requirements and rising investor interest in higher-returning niche property types.

Short-term disruption caused by the pandemic has prompted a correction in values that offers an attractive entry point, typically with some repositioning required — for example, in urban apartments, offices and hotels.

Retail headwinds have strengthened because of the pandemic, but a correction in values implies opportunities from a low base in segments of the market in which occupier demand is holding up better.

Americas

Europe

Asia Pacific

With the right approach to asset management, necessity-driven retail sites, such as neighborhood centers, can be adapted to benefit from online spending by acting as low-cost fulfillment centers.

Executive Director, Americas Investment Research PGIM Real Estate

Kelly Whitman

As the vaccine rollout takes effect, the U.S. economy is set to benefit from several tailwinds through the second half of the year, including the prospect of a full re-opening, a boost to spending from accumulated savings and further fiscal stimulus. Real estate tenant demand has turned a corner, supported by improving economic conditions and a strengthening labor market. The Federal Reserve remain committed to supportive monetary policy and the prospect of low interest rates remaining in place points towards further yield compression. With parts of the retail and office markets facing structural headwinds, investors are increasingly turning to niche sectors as a source of resilient income-driven performance.

Key factors supporting the outlook and opportunities:

There are opportunities for developments of new, modern living stock to meet rising rental demand — and also to access higher returns in non-traditional living segments, such as senior housing.

FLORIAN RICHTER

Key factors supporting the outlook and opportunities:

Across Asia Pacific, favorable demographics and declining housing affordability provide institutional investors with opportunities to participate in the early growth of the nascent rental housing sector.

Vice President, Asia Pacific Investment Research PGIM Real Estate

KAI YIP

Led by a swift rebound in China, the region’s economy is already back in expansion mode and is expected to record a rapid pace of growth in 2021 as life returns to normal. Real estate space demand is improving. There is a growing focus on occupying high-quality space although occupiers remain cost conscious. Real estate values fell only moderately in 2020, and opportunities linked to a cyclical pick-up in demand and rents or through longer-term structural trends being re-established.

Key factors supporting the outlook and opportunities:

REGIONS IN FOCUS

Vaccine rollouts should lead to a strong economic bounce back in the second half of 2021 as services re-open and households are able to spend accumulated savings. A rapid pace of growth, albeit from a low base, will support demand for real estate, creating opportunities for investors. Low interest rates and liquidity support programs are set to remain in place for some time, supporting low real estate yields. Income growth rather than yield shift will dominate the next cycle. Opportunities to outperform come from recovery in weaker sectors or growing income streams or via development or repositioning across sectors. Risk appetite is improving again, prompting a push toward higher returning operational sectors.

Non-Traditional Sectors

GLOBAL SUMMARY

A broad range of investment opportunities include capitalizing on accelerated changes in how real estate is used, investing in assets that require repositioning, and finding value in parts of the market that have undergone a long-term correction.

Evidence from past cycles and ongoing demand for real estate point toward potential overshooting, providing a source of growth opportunities in the short term.

For higher risk equity and debt strategies, there is potential to generate revenue and grow values as occupier markets recover.

For core, stabilized assets, an anticipated recovery in employment and ongoing low-supply environment provide support for occupancy and rents.

Divergent performance across global real estate markets means that an almost full cycle’s worth of opportunities is in play.

Distress in financial and real estate investment markets has been avoided and firmer growth is expected in the second half of 2021 and beyond.

The worst of the crisis has passed and 2021 is shaping up to be a significantly better year for the global economy and real estate markets.

2021 is shaping up to be a significantly better year for the global economy and real estate markets versus 2020. Explore our insights on the most attractive investment opportunities over the next 12 months.

Out of crisis comes opportunity

We make the following observations about some major factors affecting global real estate markets in 2021 and then evaluate their implications for the outlook and investment opportunities around the world.

Factors Shaping the Near-Term Outlook

01 | The Worst of the Crisis Has Passed

02 | Policy Commitment Remains Significant

03 | 2021 Will Be a Year of Two Halves

04 | Rapid Rebound in Activity Brings Opportunities

05 | Divergence in Sector Performance is Unprecedented

It goes without saying that there are always winners and losers in downturns and periods of market weakness. The difference this time around lies in how early the pattern has been established: normally, most parts of the market go through an initial period of uncertainty driven by common factors such as weaker demand, rising risk premiums, and oversupply. This time, the extent and speed of policy support — together with the nature of the pandemic that brutally curtailed demand for certain assets and amplified existing trends such as the rise of online retail — immediately and transparently boosted such sectors as logistics and left others, such as retail and hotels, struggling.

Unusually, there is a full range of cyclical opportunities in play all at the same time, with some sectors and markets delivering strong growth and attracting capital, and others facing severe occupier stress.

Divergence in sector performance is unprecedented

IMPLICATION

Unlike in past crises, there are no major pre-existing structural economic or financial issues to fix that might have otherwise required a lengthy adjustment period. In major developed economies, the opposite is the case. Job retention schemes appear to have been successful in limiting much unnecessary economic damage, and consumers have built up significant savings. As restrictions ease, the ingredients are in place for a rapid recovery. Importantly, inflation expectations remain contained, meaning that low interest rates can stay in place.

Rapid rates of growth, even though from a low base, are positive for opportunities because sentiment can improve quickly and businesses can move into expansion mode, thereby raising demand for real estate space.

Rapid rebound in activity brings opportunity

IMPLICATION

The initial recovery in economic activity in the second half of 2020 was clearly V-shaped, which has given way to a choppier pattern as restrictions to contain COVID-19 outbreaks are lifted and then reimposed regularly in many major economies. With vaccine deployment gaining pace in some parts of the world, it will start to reach the point of having a material, widespread impact on activity during the second half of the year. And though that may not herald an immediate return to pre-pandemic normality, it promises to be sufficient to lead to the beginning of a widespread easing of restrictions, which will provide a significant boost for demand.

As restrictions ease in the second half of 2021, allowing workplaces and service-oriented industries to more fully reopen, occupier sentiment is expected to return quickly supporting a rebound in real estate space demand.

2021 will be a year of two halves

IMPLICATION

Compared with past downturns, policy commitment has been significant and has given real estate markets a major boost since the COVID-19 outbreak. At a society level, the emphasis has been on overcoming the pandemic and ensuring that otherwise viable businesses are able to continue operating. In real estate markets, job retention schemes and financial support packages targeting struggling industries have translated into income receipts that are holding up better than would normally have been implied by the severity of the recession. Central banks, too, have played an important role by providing major liquidity injections and committing to keeping policy interest rates low, in turn limiting financial distress and, in effect, providing support for asset values in real estate and beyond. And even though the worst of the crisis has passed, policy makers on the whole remain committed to providing extensive support until some sort of future normality is established.

Extensive policy support is set to remain in place for some time, boosting real estate values by increasing the predictability of cash flows and by keeping low interest rates in place, reducing required returns.

Policy Commitment remains significant

IMPLICATION

Some real estate distress cannot be ruled out, but as time goes on, such distress is less and less likely to occur on a widespread basis. Sectors and markets that haven’t yet recorded a correction are now unlikely to.

IMPLICATION

Undoubtedly, conditions for real estate occupiers and investors remain challenging, yet the worst moment of the crisis was in early- to mid-2020, when the widest-possible range of outcomes was on the table, driven by concern that financial distress could affect credit flows and mass business failures could severely reduce property-level incomes. Since then, aided by policy commitment to support households, businesses and the financial system, large parts of the global economy and real estate markets have adapted to the challenges of operating during the pandemic, and activity is on an upward trend.

THE WORST OF THE CRISIS HAS PASSED

Core Equity

20% 15% 10% 5% 0% 5% 10% 15% 20%

Sector

Region

Office

Retail

Logistics

Apartment

Hotel

United States

Europe

Developed Asia Pacific

Emerging Asia Pacific

Underweight

Overweight

Underweight

Overweight

Neutral

Remain underweight but start rebuilding exposure as workplace reopenings boost tenant demand

Maintain underweight given significant ongoing headwinds, with a focus on basic needs

Maintain underweight amid a highly uncertain outlook for international travel

Continue to increase allocation given favorable occupier tailwinds, with a growing emphasis on cold storage

Occupier tailwinds remain favorable, but gradually reduce overweight as other sectors start to recover

Neutral weighting, with retail caution balanced by opportunities in apartment and non-traditional living sectors

Maintain overweight given outlook for a swift recovery and favorable real estate returns

Underweight reflects slow recovery prospects and difficulty achieving scale in logistics and living sectors

Underweight as core equity opportunities are limited

Mexico Infill Logistics

Rising amounts of online shopping are creating demand for logistics in larger Mexican cities, with low current e-commerce adoption rates providing plenty of runway for future tenant demand growth. Non-traditional property types are gaining the attention of institutional investors because of cash flow resilience, low capex and diversification. Urban apartment markets suffered a correction but performance is expected to rebound swiftly as workplaces and amenities reopen. The future of office usage is evolving rapidly, but can be seen as an extension of existing trends with demand increasingly focused on grade A space. Neighborhood retail offers resilience against increased online spending and is positioned to perform well as retail fully reopens.

Mexico Infill Logistics

Non-Traditional Sectors

Urban Apartments

Grade A Offices

Last Mile Retail

European logistics has a strong returns outlook on the back of ongoing leasing momentum. Institutions have a growing role to play in delivering modern, affordable living space for younger and older generations alike. After a tough year, offices are set for a cyclical rebound, supported by workplace returns and employment-driven economic growth. Retail is in the process of a sharp value adjustment but looks close to finding a floor in the UK, with Continental Europe close behind.

Logistics and Cold Storage

Modern Living Space

Grade A Offices

Distressed Retail

A further push toward online retail on the back of the pandemic means that the secular demand for logistics remains strong. As gateway city populations continue to grow, demand for housing – either buying or renting – will benefit from the re-urbanization trend. Tighter domestic credit growth policies are creating opportunities across equity and debt. Office demand has turned the corner, and the sector offers an attractive cyclical opportunity as staff return to workplaces. A bruised hospitality sector offers a compelling countercyclical opportunity ahead of an expected gradual recovery in demand.

Logistics and Cold Storage

Residential Sector

China Deleveraging

Grade A Offices

Hotels

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Vice President, European Investment Research PGIM Real Estate

Mexico Infill Logistics Rising amounts of online shopping are creating demand for logistics in larger Mexican cities, with low current e-commerce adoption rates providing plenty of runway for future tenant demand growth. Non-Traditional Sectors Non-traditional property types are gaining the attention of institutional investors because of cash flow resilience, low capex and diversification. Urban Apartments Urban apartment markets suffered a correction but performance is expected to rebound swiftly as workplaces and amenities reopen. Grade A Offices The future of office usage is evolving rapidly, but can be seen as an extension of existing trends with demand increasingly focused on grade A space. Last Mile Retail Neighborhood retail offers resilience against increased online spending and is positioned to perform well as retail fully reopens.

20% 15% 10% 5% 0% 5% 10% 15% 20%

Evidence from past cycles and ongoing demand for real estate point toward potential overshooting, providing a source of growth opportunities in the short term.

For higher risk equity and debt strategies, there is potential to generate revenue and grow values as occupier markets recover.

For core, stabilized assets, an anticipated recovery in employment and ongoing low-supply environment provide support for occupancy and rents.

Divergent performance across global real estate markets means that an almost full cycle’s worth of opportunities is in play.

Distress in financial and real estate investment markets has been avoided and firmer growth is expected in the second half of 2021 and beyond.

The worst of the crisis has passed and 2021 is shaping up to be a significantly better year for the global economy and real estate markets.

Long-term Correction

Short-term repositioning

Ongoing Tailwinds

Accelerated change

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REASONS FOR OPTIMISM

Returns over the next cycle are expected to be lower than in the past, but there are reasons to be optimistic, including prospects for employment growth, an ongoing low supply environment and investing in active investment management strategies.

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Global outlook

2021

A Crisis Brings Opportunity

Download Report

EXPLORE FINDINGS

HEAR FROM OUR EXPERTS

View Webinar

with Greg Kane

REASONS FOR OPTIMISM

with Kai Yip

ASIA PACIFIC

with Florian Richter

Europe

with Kelly Whitman

AMERICAS

Global outlook

2021

A Crisis Brings Opportunity

Download Report

EXPLORE FINDINGS

View Webinar

HEAR FROM OUR EXPERTS

with Greg Kane

REASONS FOR OPTIMISM

with Kai Yip

ASIA PACIFIC

with Florian Richter

Europe

with Kelly Whitman

AMERICAS