How The Continued Rise Of Nationalism Will Hit Real Estate Capital Flows And Values
Because most people employed in real estate today have only ever worked in a globalised world, it can be hard to imagine how it could be any other way.
But the prevailing mood around the world is increasingly opposed to globalisation, with political and economic nationalism and protectionism on the rise. From Brexit, to President Donald Trump’s trade tariffs and America-first policies, to an increasingly nationalistic government in India and other emerging economies, growing inequality has led to a pushback against the idea of an increasingly interconnected world.
That could have big implications for the commercial property sector.
The real estate industry has been a big beneficiary of globalisation: 40% of global real estate deals last year were cross-border, according to JLL, up from less than 10% at the beginning of the 1990s. Increased globalisation has brought in more investors and pushed up prices and thus increased the volume of professional fees in the sector.
But what might happen if globalisation continues to reverse? That is the question posed by the UK’s Investment Property Forum in a new paper, Global Capital Flows in a World of Increasing Nationalism & Protectionism. So far, there has been little impact on global real estate capital flows: Capital controls have caused Chinese investors to pull back from global markets, but they have largely been replaced by other investors in a world where real estate is attractive because of low rates.
But over the next decade, if things continue in the same direction or the world becomes even more fragmented, the picture might not be so rosy, the report said. There could be far fewer cross-border transactions, causing fee income to drop and advisers to shrink their global footprint and cut headcount. Prime assets could drop in price, rents could lower as occupiers retrench and some markets could become out of bounds for investors. Residential and logistics assets would face a very tough time. And that is the the base case if things simply don’t get much worse.
“The rise of nationalism and ardent protectionism threaten to upend the status quo that has been decades in the making,” said CBRE Global Investors European Head of Research and Strategy Andrew Angeli, who was on the steering committee for the research paper. “In my engagement with global investors, I am spending increasingly more time assessing current political affairs and the sustainability of investing in markets perceived to be safe havens.”
The paper was authored by directors from real estate data firms Didobi and Real Capital Analytics and political and economic risk analysis firm Control Risks. It outlined two potential scenarios for how politics might evolve between now and 2030, and asked how real estate investment capital flows might be affected in each.
The first would be a broad continuation of recent trends. Trump is re-elected, and continues to pursue bilateral trade deals and impose ad hoc tariffs. No other country leaves the European Union, but the truce between members remains uneasy. The Middle East and East Asia remain volatile, but there are no full-blown wars there.
The second scenario is much starker, and although the report’s authors said it is not the most likely outcome, they said it is very plausible. In it, the world separates into two distinct spheres of influence, one governed by the U.S. and one governed by China, and businesses have to essentially choose one in which they operate, with little capital, merchandise or information flowing between the two. As extremist parties gain more prominence, Italy and other countries leave the EU, and the union begins to fracture. The Paris climate agreement collapses, and emerging economies are drawn into more and more conflicts over resources.
Triggers for this scenario include growing tension between the U.S. and China, and security threats leading to war in the Middle East or Korea.
The authors point out that because real estate is an immovable asset class, it is more at risk at times of growing isolationism. Unlike money, shares or bonds, it is impossible to quietly move a building from one jurisdiction to another (although William Shakespeare did it once). This also makes it the easiest asset class to interfere with politically, including through increased taxation.
“Capital flows will be restricted under either scenario, but more dramatically under fragmentation,” the reports authors wrote.
The implications are complicated but dramatic.
Those markets that have benefitted most from globalisation of capital markets could see significant structural changes in their sources of capital, with global investors being replaced or at least partially replaced by local ones, the report said.
“This could lead to a fall in turnover and ultimately falling prices, especially in the event of the forced sale of prime assets.”
Markets the authors picked out include London, New York, Washington, Dublin, Hong Hong, Sydney, Paris and Amsterdam.
London would be particularly badly hit by any pullback in foreign capital, because its market is simply too big for domestic investors to pick up the slack. The same is true of Helsinki and Madrid. If the world did break into an American and Chinese sphere of influence, that would also be bad for London, because of its popularity with Asian investors.
Indeed, the report identifies the UK as generally very reliant on foreign capital, and highly exposed to any reduction in global capital flows. Belgium, Canada, Denmark, Finland, India, Ireland, Italy, Russia and Spain are others. The U.S., as a big market with plenty of domestic capital, would be more insulated. But not totally.
The West would suffer more from a reversal of global capital, especially if the world split into two distinct regions that didn’t interact much. About 25% of global deals include money moving between the two hemispheres, and 80% goes from East to West. As the East grows more wealthy, its importance will grow.
Any reduction in cross-border capital would hit prime assets in big cities hardest, as these tend to be the assets bought by international investors. As a result, the gap between prime and secondary yields could narrow, with cap rates for the best assets rising.
“At a market level, the entire sector may suffer a crisis of confidence, with investors simply deciding that the risks no longer justify the return,” the report said. “The risk cost of holding immovable physical assets may cause many investors to exit the market in favour of indirect real estate exposures via equity and debt instruments.”
In terms of sectors, residential and logistics are most at risk, with the report pointing out that this is a possible problem down the line for the “beds and sheds” strategy so beloved of investors right now.
Residential is inherently the most political of asset classes, and particularly in big gateway cities, the clamour against foreign owners pushing out ‘locals’ is already high. Many countries across the world including the UK and Canada already place restrictions on foreigners in the form of higher taxes or restrictions on ownership.
Increases in protectionism have the potential to affect supply chains that today are global and stretch across many countries. These supply chains would be severely disrupted, impacting logistics occupiers and affecting the value of logistics assets, although there could be money to be made from occupiers needing to re-establish shorter, more national supply chains.
For occupiers more generally, the more benign scenario outlined in the report does not have a huge impact, but increases in taxes and tariffs could have the impact of forcing occupiers to think about in exactly which countries they absolutely have to operate.
Any pullback of global capital would not just be about money, the report argued: It would also be very much about people. “An entire ecosystem of brokers, valuers, lenders, assorted advisers/consultants and tax authorities depend on transactions for revenue, and for every person directly employed there are a further three to four people in indirect or induced jobs,” it said. “Lower volumes over a sustained period will lead to ‘right-sizing’ among corporates and a search for alternative revenue sources for the taxman.” It estimated that if transaction volumes drop by 10%, that means a $1.3B drop in revenue for the world’s biggest brokerages.
“Looking forward to 2030, global capital flows will undoubtedly be affected by increasing nationalism and protectionism,” the report said in a final thought. “Political risk and liquidity risk, often considered to be separate risks, will increasingly be viewed as intertwined. In a world of state interference and rising nationalism the price of liquidity may need to be recalculated to include hard economic and political factors."