2012 | MARCH

GLOBAL OUTLOOK
Grosvenors research perspective on world real estate markets
www.grosvenor.com

View from the US: The recovery will continue, but patience is still required
The turnabout in sentiment has been impressive. Just a few months ago, a potentially devastating European recession loomed, and key sectors of the economy were failing to gain traction. Today, by contrast, we find ourselves in the midst of better-than-expected growth, supported by a broad uptick in economic indicators. Our view is that this surge in the recovery does indeed have substance, but various sources of weakness remain. As a result, we think that the recovery will continue at a moderate clip, but more robust growth will remain elusive in the near-term. The basis of our optimism lies in employment growth. Thus far, we have remained sceptical of embracing any recovery until a pattern of substantive job growth commenced. We have been pleasantly surprised over the last few months. The US economy added over 200,000 jobs in each of the last three months through February, leading to a substantive decline in the unemployment rate. Other employment indicators affirm the positive trends: declining new claims for unemployment insurance, increased number of job openings, and rising intentions of small business to hire.
US disposable income growth
8%

Nevertheless, the recovery will be hampered by a number of factors. One of these is the impact from Europe, which is expected to affect growth particularly in the first half of the year. Further Federal, state, and local government fiscal austerity measures and the expiration of certain stimulus programs will also have a negative impact on domestic demand. In addition to these headwinds, we remain sceptical of the ability of two major sectors of the US economy, housing and consumption, to provide enough fuel for a really robust recovery. Within the housing sector, the for-sale single-family market has clearly bottomed, but prices and new starts will only recover gently over the year ahead. Fortunately, a vibrant rental market is ameliorating housings drag on overall economic growth and, in fact, is becoming a good source of construction jobs for the economy. Perhaps the most important reason for caution is the outlook for consumption, nearly 70% of the economy. The US consumer continues to de-lever, and the savings rate remains elevated. We think it will take American consumers at least until 2015 to return to the long-term average in their use of leverage. Furthermore, not helping matters has been unremarkable income growth. The recent ascent in oil prices provides another challenge, and is a significant wild card to derail growth in 2012. In short, while the US recovery seems to be back on track, we think it will fail to meet the more optimistic expectations. Stronger growth is unlikely to begin until the consumer is unleashed and single-family housing accelerates. This said, we do think that the US will be a source of economic stability in a world of uncertainty.

Year-over-year growth; inflation-adjusted (2005 USD)

6%

4%

2%

10-year average

0%

-2%

-4%

-6%

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Oct-07

Oct-08

Oct-09

Oct-10

Oct-11

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Source: Moodys Analytics

Ian Anderson Americas

Japan: Policy tailwinds to strengthen cyclical property recovery

In the past year, Japan encountered a maelstrom of headwinds triggered by environmental events. The resurgence in economic growth post the Great Financial Crisis was hindered first by the Tohoku earthquake and then by the disruption to production caused by the Thai floods. The growth contour in 2011 consequently mirrored this unexpected sequence of events. After contracting by an average of 4.2% in the first half of 2011, growth rebounded by a sharp 7.1% in Q3 based on strong pent-up business and consumer demand. However, production delays due to the flooding in Thailand on top of slowing global demand and the strong yen, led to a 0.7% drop in growth for the last quarter. Overall, the Japanese economy fared worse than expected in 2011, contracting by 0.7%. Against this uneven macro backdrop, it is unsurprising that there are considerable and widespread concerns over the recovery prospects for Japan. Nonetheless, there are strong reasons to believe that the cyclical drivers for a recovery are in motion along with some other positive factors. Domestic conditions are improving. Business surveys point to a positive mood among non-manufacturing firms (Chart 1). The December headline service sector activity index has surpassed pre-earthquake levels, particularly in discretionary personal services. With the February services PMI reading also running at elevated levels, positive business expectations for the coming year remain firm. Overall, the improved outlook reflects not just a normalising business environment following the massive disruption from the earthquake. Improved sentiment is also translating into better labor market conditions, consumer confidence, spending and finally retail sales. External outlook is stabilising. Many forecasters have marked up global growth this year, reflecting
Chart 1: Economic outlook
55 50 102 45 100 40 35 30 96 25 94 20 15 92 98
Index 2005 = 100

easing concerns over the euro zone sovereign debt crisis, better-than-expected data from the US and a soft landing scenario for China. While external uncertainties remain, prospects for trade will slowly improve as global demand recovers. The drag on economic growth will lessen as supply chain disruption to production eases together with a reduction in imported fuel substitutes for nuclear power. The positive growth momentum in production and machinery orders received for exports underscores a better picture for Japans trade sector this year. Back-loading of reconstruction stimulus is taking place. Although JPY21 trillion has been earmarked to rebuild the areas devastated by the March disaster, the boost to growth has so far been limited by delays in disbursement and a shortage of construction labor supply in the affected areas. Thus, public investment in Q4 fell by 9.5% on top of a 6.2% decline the quarter before, after posting a 28.9% rise in Q2 immediately after the earthquake. This back-loading of reconstruction spending this year will substantially boost growth, cementing an above-trend cyclical recovery even if the drag from weak external demand persists. Policy tailwinds to strengthen growth prospects further. A recurring feature of Japans economic performance over the years is that private sector demand has stayed relatively sluggish, even with zero interest rate policy and more than enough banking system liquidity. However, the recent decision by the Bank of Japan (BOJ) to increase Japanese Government Bond (JGB) purchases in the Asset Purchase Program (APP) and pursue a more binding 1% inflation target at the same time is a significant shift in policy with very positive growth implications. In February, the BOJ announced plans to increase the APP to JPY65 trillion (from JPY55 trillion) via JGB purchases to be completed by the end of the year. The central bank has raised the ceiling on its APP every four months on average since October 2010. The latest initiative to spend JPY10 trillion solely on JGB purchases will more than double this years target from JPY9 trillion to JPY19 trillion. At the same time, the BOJ also announced an explicit inflation goal of 1% . While the policy change was not directed at financing the fiscal deficit, it appears that future additional fiscal spending is more likely to be financed by the BOJ. Effectively this is initiating debt monetisation. The direct impact of such a move going forward is an increase in monetary base (and aggregate demand) finally leading to a rise in price levels and a decrease in the value of the JPY. If the BOJ continues to aggressively increase the APP in the coming months, the combination of rising inflation (in Japans case, the timing depends on how sticky the deflationary mindset is) and yen

104

Nov-09

Nov-08

May-09

May-10

Nov-07

Nov-10

May-08

May-07

Aug-10

Aug-09

Aug-08

Aug-07

May-11

Feb-09

Feb-08

Feb-07

Feb-10

Aug-11

Nov-11

Feb-11

Economy watchers survey: future economic conditions (lhs)

Source: CEIC

Tertiary industry activity index (rhs)

Feb-12

Chart 2: Lending to the real estate sector

15
Percent change, year-on-year Percent

15 10

10

5 0

-5 -10

-15 -20

-5

-25 -30

Macro cyclical upturn: The projected improvement in economic growth is likely to lead to a more robust and sustained rebound in domestic demand conditions, providing a positive feedback loop between business expansion and job market conditions and benefitting office and residential rents which are both at cyclically low levels. On top of the step up in rents, the coupling of BOJ debt purchase and inflation target will also lead to a more concrete improvement in investment demand steming from improving financial conditions, increasing asset prices and economic activity. Debt/equity liquidity improvement: Bank lending to the real estate sector has been steadily growing, corroborating the message of the December BOJ Tankan Survey readings which show ongoing improvement in actual lending attitudes to the real estate sector (Chart 2). The mix of uncertain economic conditions in the US and euro-area and full valuation in many emerging Asian markets has also led to increasing interest in the core Tokyo market, where relatively attractive pricing and yield spreads exist. The improving liquidity picture will lead to a recompression of cap rates in the coming quarters, following the stall due to the March earthquake. The return of J-REITS to the market in the past year - as shown by increasing acquisition and disposal activity - will also help supplement the upturn.

-10

-35

Mar-04

Mar-03

Mar-06

Mar-09

Sep-04

Mar-05

Mar-08

Mar-02

Sep-03

Mar-10

Mar-07

Sep-10

Sep-06

Sep-09

Sep-05

Sep-08

Sep-02

Sep-07

Mar-11

Sep-11

Bank lending 2Q MA (lhs)

Source: CEIC

Tanken survey on lending attitudes (rhs)

depreciation will provide a virtuous circle of economic growth (through stimulating spending, as debt burden is transferred from debtors to creditors, and exports) and financial asset price rises leading to an increase in nominal real estate values and potential gains in equities. Growth leading to sustained and strong real estate recovery. The Tokyo property market is on the cusp of a steadily strengthening recovery. While real estate prices have increased since the global financial crisis, a full-fledged upturn has yet to occur due to a confluence of dampening factors: (1) highly uneven economic performance as previously described; (2) refinancing workouts, the pull out of foreign capital and the collapse of the CMBS market holding back investment demand, and; (3) supply/demand imbalance especially in the Grade B office and mass residential sectors holding down rents. From a cyclical perspective 2012 provides a unique and attractive window of opportunity to enter the Tokyo real estate market. The key drivers of the real estate upturn will be:
Chart 3: Grade B office rents
40,000
JPY per tsubo

Demographic boost to housing: Despite an aging population, there remains a strong case for investment in the Tokyo housing market. Rising migration into Tokyo, children of the baby boomers (who make up around 15% of the population) with the financial capacity to purchase their first home, low financing costs and tax breaks will combine to provide a demographic sweet-spot for the housing market in the coming years. The stars are aligned to provide good returns in the Tokyo real estate market. The time to enter the market is now. Price and rental levels are still near their lowest levels leading up to a projected cyclical recovery (Chart 3). Improving liquidity coupled with policy and demographic induced demand will first trigger and then further strengthen and deepen the duration of the upturn, providing an attractive window of opportunity to invest, achieving strong income and capital returns.

35,000

30,000

25,000
32%

20,000

15,000

10,000

2000

2004

2006

2010

F-2014

2008

2002

1994

F-2016

F-2012

1996

1998

1992

Source: Grosvenor Research

Harry Tan Asia Pacific

Research Team Contacts

Richard Barkham Group Research Director T +44 (0)20 7312 6388 E richard.barkham@grosvenor.com Maurizio Grilli Global T +44 (0)20 7312 6367 E maurizio.grilli@grosvenor.com Cynthia Parpa Global T +44 (0)20 7312 6332 E cynthia.parpa@grosvenor.com Graham Parry Britain & Ireland T +44 (0)20 7312 6234 E graham.parry@grosvenor.com David Inskip Britain & Ireland T +44 (0)20 7312 6351 E david.inskip@grosvenor.com

Aneta Wiak Britain & Ireland T +44 (0)20 7312 6199 E aneta.wiak@grosvenor.com

Eileen Marrinan Americas T +1 (415) 268-4038 E eileen.marrinan@grosvenor.com

Ian Anderson Americas T +1 (215) 575-3783 E ian.anderson@grosvenor.com

Batrice Guedj Continental Europe T +33 (1) 44 51 75 52 E beatrice.guedj@grosvenor.com

Harry Tan Asia Pacific T +852 2501 1922 E harry.tan@grosvenor.com

Questions & Answers with Dr Richard Barkham, Group Research Director

Each month, for the last eleven years, Grosvenors research team has produced an edition of Global Outlook. Collectively the articles chart the impact of globalisation on the volatility and performance of world real estate markets. The articles will be published by Wiley Blackwell under the title Real Estate and Globalisation on Friday, March 23, 2012. Grosvenor Group Research Director, and author of the book, Dr Richard Barkham MRICS answers questions about the book. Q: Richard, what motivated you to write a book on real estate and globalisation? A: Well, I have been interested in the macro economic consequences of globalisation for a long time. Globalisation, or more specifically the opening up of labour markets and the shift of manufacturing from the advanced countries to emerging markets, has many benefits. It dramatically raises the incomes of some of the worlds poorest people and simultaneously allows OECD consumers to enjoy very cheaply manufactured goods. However, the consequences of globalisation are not all good. For instance, it is not only cheap goods that are flowing out of places like China, but cheap capital as well. From the mid-1990s these huge capital flows found their way into the US bond market, raising prices and reducing yields. In turn, a combination of low inflation and low interest rates caused a series of asset price bubbles the most recent of which was the real estate boom which preceded the Great Financial Crisis. In other words, the process of globalisation, which has generated some much economic growth also helped to create the debt mountain, we are now struggling to reduce. When I reviewed eleven years of Global Outlook articles, I found that they told a very interesting story of the impact of globalisation on world real estate markets. Q: The book seems to cover a range of topics, for instance, ination, retail, ofces, residential, construction and yields: are these all relevant to the topic of globalisation? A: I would put it in another way; I do not think that there is any area of the real estate market that has been untouched by the forces of globalisation. Take inflation for instance. The fall in inflation is due in part to the flow of cheap goods from emerging markets, particularly, as I have said, China. Falling inflation has led to a fall in bond yields which has also pulled down property yields over the last 20 years. Western consumers, particularly in the UK and the US have had a great time buying cheap goods. Many new shopping centres and new retail warehouse parks have been constructed to facilitate the distribution of these products. Cheap capital also led to the over-expansion of the banking sector. This created demand for shiny new offices in the worlds financial capitals: London, Hong Kong, Tokyo and New York. More directly, economic growth in emerging markets has led to one of the biggest construction booms of all time: one that is on-going. This has raised the price of raw materials and had an adverse effect on the cost of real estate development in the OECD rasing the cost of occupation in the long run. Q: So, do you think that globalisation is a good or bad thing? A: Unequivocally, I think that it is a good thing. As I have said, it spreads the benefits of economic growth to some of the worlds poorest people. However, all economic systems need some form of management. I am concerned that the emerging markets have not yet been fully integrated into global economic policy making, through, for instance, the G20, the IMF and the OECD. There is an urgent need to do this, so that emerging market growth and the capital outflows it creates do not destabilise the global economy by continually creating asset bubbles, including those in the real estate sector.

This edition of the Global Outlook, along with all previous articles can be found on the Latest Research and the Research Archive sections of our website www.grosvenor.com/research.
This document is for general informative purposes only. The information has been compiled from sources believed to be reliable however its accuracy and completeness are not guaranteed. The opinions expressed are those of the Research Department of Grosvenor Group Limited ("Grosvenor") at this date and are subject to change without notice. Reliance should not be placed on the information, forecasts and opinions set out herein for any investment purposes and none of Grosvenor, its affiliates, officers, employees or agents accepts any liability arising from such use or any other use, or for the contents of this document. This document is intended for professional and non-private investors only. No part of this publication may be reproduced in any form without the prior written permission of Grosvenor.