Global economic outlook

January 2024 started with a strong consensus around global inflation being under control, US growth moderating into a soft landing, and monetary policy easing to start soon. While something of a moving target, markets are still pricing-in an elevated probability of the Federal Reserve (Fed) easing from March.

But there are new and old inflation risks. As a spillover of the Israel-Hamas conflict, Iran-backed Houthi rebels in Yemen have disrupted shipping through the Red Sea. This has added several weeks to Asia-Europe transits, with the potential to increase the price of goods.

Meanwhile, productivity-adjusted wage growth is still running ahead of target inflation rates in many economies. While wage growth has been moderating, central banks are not yet convinced all the work has been done to cool inflation.

We expect global growth to slow by more than consensus. But there will be divergence. The UK and Eurozone are already in recession-like conditions, while the US is only likely to dip into a contraction later in 2024. There is a clear route to a US soft landing, but we expect waning support from household savings to move the economy into a mild recession.

In China, recent data shows growth stabilising amid policy easing. However, we forecast economic growth in 2024 to be below target, given the twin headwinds of subdued household confidence and housing market retrenchment.

Central bank caution may delay the start of easing cycles, relative to current market expectations. We expect rate cuts to begin by the middle of 2024. We think the eventual trough in policy rates will be lower than both markets and central banks expect, given lower-growth forecasts and lower interest rates. 

A broad emerging market (EM) rate-cutting cycle may have to wait until the Fed lowers interest rates. But by mid-2024, many EM central banks should be cutting too. This is because of cooling inflation, growth slowing below-trend in many EMs, and the high starting point for real rates. 

The Bank of Japan is a notable exception among the major central banks, as it is likely to tighten policy this year. We expect yield curve control and negative interest rates to be removed after the spring Shunto wage round.

Taiwan, India, Mexico, the US, the EU and the UK all head to the polls in 2024. Trump is the marginal favourite to win the US presidential election, but much will ride on the state of the economy and Trump’s legal issues. These elections look set to further embed themes of political polarisation, geopolitical uncertainty, and the changing nature of globalisation.

UK real estate market overview

While UK real estate capital values decreased over the course of 2023, the pace of decline has moderated. There are tentative signs of stabilisation for some sectors but not all. There is a risk that further price discovery in the first half of 2024 will result in softer pricing, particularly for out-of-favour sectors. Performance has been varied across sectors, with those benefiting from structural and thematic tailwinds proving more resilient in the face of a weaker macroeconomic environment. The logistics and living sectors are a clear example of this trend, both outperforming the wider market over the course of 2023.

UK real estate capital values fell by 2.6% in the fourth quarter of 2023. This resulted in value declines of 5.6% for the year, according to the MSCI Monthly Index. In line with our expectations, the living and logistics sectors outperformed the wider market, with capital value growth of 1.9% and 0.1%, respectively, during 2023. The office sector remains the laggard. It recorded a capital decline of 16.6% over the same period, as the sector struggled with changing working habits, higher financing costs, and weak investor sentiment. 

At the All-Property level, total returns for the calendar year 2023 were -0.1%. The largest negative contributor to performance was the office sector, which returned -11.9%. The residential sector was once again the strongest performing sector, returning 8.2%. The industrial sector returned 5.1% over the same period.

UK real estate investment volumes for the calendar year 2023 reached £34.3 billion, according to Real Capital Analytics. This represents a year-on-year decline of 47% and means that 2023 was the weakest year for investment activity since 2009. The investment market has been affected by a significant gap between buyer and seller aspirations across several sectors. The buyer pool for UK real estate was thin in 2023 and we expect this to be the case in the first half of 2024. While we expect greater liquidity to return to the market in 2024, this will in part be driven by buyer and seller expectations becoming more closely aligned. 

The UK real estate listed sector ended the year on a high, with the FTSE EPRA Nareit UK Index posting a total return of 18.9% in the final quarter of 2023. It significantly outperformed the FTSE All-Share Index, which recorded a total return of 3.2% over the same period. The recovery in UK real estate investment trust (REIT) performance in the fourth quarter of 2023 was driven by the market pricing-in an increased probability of rate cuts in the second half of 2024. This is mainly because of better inflation data and the expectation that peak rates have been reached. This was clearly illustrated by the UK interest rate swap market, with the five-year swap reaching lows of around 3.3% by the year-end. This was considerably lower than the peak of around 5.3% that was reached in July 2023. The UK listed real estate index has historically led the UK direct real estate sector by six-to-nine months, which adds weight to the argument that the fortunes for the latter will improve over the course of 2024.

European real estate market overview

The outlook for European direct real estate returns is improving each quarter. We forecast European All Property total returns of 1.8% over the year to December 2024. This is before a healthy recovery kicks in with three- and five-year annualised total returns of 7.4% and 7.8%, respectively. Following the 17% decline since June 2022, we anticipate a further 3% fall in European excluding UK All Property values over the year to December 2024 (offices -5.7%, industrials –2.3%, retail –4.4%, and residential +0.4%). Now that interest rates are likely to have peaked, we believe the yield revaluation phase is nearing the end.

Downside risks to our forecasts are elevated because of the weak economic outlook. Given the persistent uncertainty, we are still advocating a low-risk approach for existing mandates in the first half of 2024. This means reducing leverage and development exposure, reducing voids, and retaining higher cash weights.

However, we also believe that better entry prices for core and value-add assets will arise from today. 

Asia-Pacific (APAC) real estate market overview

We expect near-term capital returns to remain under pressure. But we have trimmed the projected decline to reflect the prospect of an earlier-than-expected start to rate cuts, led by the Fed. Over the longer term, our base case remains that interest rates will retreat to lower levels. In fact, we expect the net effect of demographic change to be negative for interest rates up to 2030. According to abrdn’s Global Macro Research team, a falling labour contribution to potential growth more than offsets upward pressure from ageing populations. Moreover, downward pressure on rates across the largest economies means the global financial system provides another check against upward pressure. We expect lower interest rates to therefore support better capital returns beyond the immediate 12-24 months. Higher property yields in the near term are likely to provide good opportunities for investors to pick-up grade-A assets in core locations. 

Macroeconomic drivers and geopolitical developments will have a bigger impact on real estate’s near-term performance. While US rates appear to have peaked, and the Fed could bring forward its first cut if data were to deteriorate faster than expected, geopolitical developments and their impact on supply chains remain highly fluid. These could affect inflation and interest rates in unexpected ways. Within APAC, Australia’s inflation remains sticky, and the risk is that rates will rise further in Australia, even as the US pivots. This would have implications for property yields and capital values.

North American real estate market overview

We are bearish on US offices, as occupiers struggle to get employees back into the office. Weekly physical occupancy seems to have plateaued at around 50% nationally. Effective rental growth will be weak as sublease availabilities force direct landlords to entice occupiers with increasingly large concessions. We are even seeing an increase in subleases for buildings on their first leasing cycle. Recovery for the office markets will be a long and played-out affair. A large amount of inventory still needs to be withdrawn before we see an improvement in the supply/demand dynamics.

Established east-coast population hubs are proving positive for multifamily assets. Despite the large national volume of deliveries, supply in the east coast is expected to remain limited. Pockets of forced sales may come up on smaller properties in the east coast and Sunbelt markets. These are likely to be for properties financed between 2020-2022. This could offer buying opportunities.

We like strip retail, lifestyle centres, and standalone retail, particularly grocery or discount-store-anchored properties in the Sunbelt and Midwest. These should benefit from higher population growth and the limited supply pipeline, but they will face headwinds as economic conditions deteriorate.

We are bullish about industrial and logistics markets surrounding the Gulf and east-coast ports. We think these ports should be primed to capture more shipping volumes as friendshoring becomes more prominent. Recent infrastructure upgrades to the ports of Savannah and New Jersey should attract more shippers because of nearshoring/onshoring opportunities. Land-border traffic is expected to grow because of nearshoring. This is expected to give a boost to markets with established intermodal terminals, such as Chicago and Dallas.

Global market summary – outlook for risk and performance

As we move into 2024, we anticipate that the majority of the real estate pricing correction has played out at an All-Property level. However, expectations for capital values vary at a sector level. Assets in sectors that are unlikely to benefit from thematic tailwinds are particularly vulnerable. Poor-quality assets, where future retrofit costs are rising because of more onerous environmental legislation, are also unlikely to perform. We expect further capital decline for these types of assets. Although we are more positive about the market’s prospects, the early months of 2024 are likely to be a challenge. Investment activity remains subdued and sentiment has yet to recover markedly. We expect activity and sentiment to improve as the year progresses. We remain very positive on sectors with strong fundamentals, such as the industrial, residential and alternative sectors. Vacancies are low in these sectors as is future supply; demand also remains strong and is benefiting from thematic tailwinds. In the wider market, uncertainty remains elevated because of the ongoing geopolitical and inflationary concerns. We expect interest rates will start to fall further on into the year, as inflation moderates, which should bolster real estate’s relative pricing. We also expect weak economic growth generally and the likelihood of a mild US recession further on into the year.

In this forecast environment where demand is subdued, tenant strength and income resilience will be the focus as recession hits demand. We aim to target good-quality occupiers with a strong credit rating in this phase of the cycle. Polarisation between good and poor-quality assets remains elevated. It is becoming more pronounced as investors continue to target good-quality assets with strong environmental, social and governance credentials, which are likely to meet future tightening environmental standards. Poor-quality assets in sectors with weak fundamentals, such as the office sector or lower-quality parts of the retail sector, are expected to bear the brunt of the further corrections in value. A key risk to our outlook is inflation remaining stickier than the market currently expects and interest rates potentially remaining at their current levels for longer than we anticipate. This would lead to further price decreases for real estate than we currently expect.