Amid fears over the impact of weaker Chinese growth and resulting stock market turmoil, investors’ confidence has been sorely tested of late and some are questioning the likely impact on property. Will it derail the slow economic recovery now filtering into occupier markets? Will it bring to an end the wave of Chinese and other Asian capital coming to Europe? Will it end the steady loosening in risk tolerances that has encouraged investors to look further afield for opportunities and spread demand to second tier markets?
It is of course difficult to assess which way investors will jump at this time of the year, but our reading of the situation is that these risks are being exaggerated and markets will soon settle again. While the implications of a slowdown in China could be far reaching – both for global growth and confidence – China’s woes are really more a form of growing pains as it adjusts its economic model towards consumption over investment and introduces reforms to open up its economy. The authorities are under pressure of course and politics rather than economics could be a more significant risk. However, measures are in place to stabilise demand and while the exceptional growth of recent decades is past, returning to growth of 6-7% pa from a now much larger economy is still enough to keep Chinese prosperity moving forward and drive global growth as well.
At the same time, this volatility as well as a shortage of domestic investment opportunities and demand for diversification will continue to drive Chinese capital towards global markets. What is more, liberalisation in areas such as foreign exchange and the stock market is part of a positive long-term trend that will boost confidence in China as a business partner and help to maintain a two-way flow of capital and investment.
The correction in China’s exchange rate and stock market are arguably efficient market reactions, righting a previously artificial regime. The Yuan for example had risen strongly over the past year because of its dollar peg – despite the weakening in the domestic economy. With the currency now lower, this should help Chinese exporters as well as bear down on consumer prices in the West, thereby boosting spending power but also sustaining low inflation and hence the “lower for longer” interest rate environment we are in.
Indeed, what is arguably more important in the short term than China is what is happening at the Federal Reserve and when this era of cheap, abundant money is going to start coming to an end. Every time we approach a point where QE or monetary policy are to be tightened, markets take fright, however well sign-posted the move is. A Fed rate rise is now being pushed back in most commentators’ minds for example but while inflation is low, growth is improving so a rate rise this year must still be a strong possibility. Hence uncertainty and volatility will persist for some time, particularly given the likely slow pace at which interest rates will reach their new normal.
So with an environment where interest rates will stay low for longer but investors will be nervy of the risks around them, the current period of strong demand for stable, income producing property should persist and the cycle will be longer than usual. With still rising liquidity and more profit taking, activity is set to remain high, if not increase further, while yields will be pushed lower as short and long term interest rates remain rooted to the floor. We can expect a maintenance of high demand for core property in particular from a risk-averse investment community and while the spreading of demand to new markets will continue, not all markets will benefit, with close attention on local risk premiums.
European growth expectations may edge down but the expansion will still be stronger than last year, with nervousness over Greece taken in the market’s stride despite the fresh elections due this month. At the same time, cash rich businesses are being pushed to invest and corporate activity will increase, benefitting occupier markets, with the portents for retail in particular brightening. Demand will focus on the right property and locations however, with low inflation signalling no generally rising rental tide. A focus on fundamentals is therefore key: investors need to price potential carefully and those that chose to overlook local occupational demand in favour of the performance enhancing benefits of leverage may regret it when interest rates rise.
Excerpt from forthcoming report
David Hutchings, Head of the European Investment Strategy