What a difference a year makes. For the world economy as a whole, the outlook has improved considerably. As a result, investors can find optimism in the real-estate market in a number of ways. First, stable employment growth in most markets should continue to translate into sustained tenant demand for property. Second, inflation-adjusted or "real" interest rates tend to be low, if not negative, in most markets; moreover, real rates remain below historic averages suggesting limited capital-market risk.
The third factor relates to fiscal policy, which has become less austere and, in the case of the United States, very supportive of economic growth. This contrasts sharply with the picture for much of the last decade. Fourth, the risk of recessions looks very limited. While we are likely to see central banks increase short-term rates in the United States and some other markets, marginal increases in rates would still lead to below-average interest rates and positively-sloped yield curves. Viewed through the lens of history, this suggests the next U.S. recession remains unlikely within our 12-month forecasting horizon. Fifth, while there are pockets of excess supply, new construction activity generally remains below historic averages.
Furthermore, we are not seeing the type of aggressive and accommodative leverage used in the real-estate market leading up to the credit crisis. Indeed, the market for commercial mortgage-backed securities (CMBS) remains a shadow of its former self in both Europe and the United States. Institutional and bank lending also appears to have acquired a higher degree of discipline. As a result, real-estate-income yields provide a reasonable risk premium compared to lending rates. To be sure, there has been some volatility in the financial markets recently, but as my colleagues argue, any tightening in financial conditions should be temporary.
With these factors in place, we expect real estate globally to continue to provide attractive total returns in the range of 5% to 8% on an unleveraged basis through 2019 and outpace the bond market while providing a competitive return to equities. What has changed is the expected relative performance of various regions. Moreover, broad regional figures overlook the dispersion in returns that can be achieved at a city, country or sector level. For example, we expect total returns of 6% to 7% for the United States through 2019. However, we believe higher returns can be achieved by overweighting the industrial and logistics sector while also underweighting certain large markets, such as New York or San Francisco, which comprise a disproportionate share of the index.
Turning to Asia Pacific, we remain very positive on the region, expecting higher total returns than the U.S. in the range of 6% to 8%. The real-estate market in Asia Pacific is underpinned by economic growth well in excess of the rates seen in the United States and Europe. The core office and logistics markets in Australia should continue to outperform our regional average. Japan is also expected to post high-single-digit levered returns due to the low cost of borrowing and improving economic prospects. Singapore, which traditionally sees a wide dispersion in returns through the course of a market cycle, is once again poised for a cyclical recovery due to improving global economic trade.
Finally, economic prospects in Europe have turned markedly more positive over the last twelve months. Over the next two years, we expect prime total returns in the range of 7% to 7.5%. While supply is increasing, declining unemployment in most markets combined with strong occupier demand, positive rent growth, higher releasing rates and declining vacancy rates should lead to positive momentum in total returns in 2018. Furthermore, swap-spread rates remain low. Within a global context, the European real-estate market appears like an attractive destination for a number of international investors. Of course, a proper global diversification strategy, taking into account relevant foreign-exchange-rate risks, remains critical. So does selecting the right segments and locations within each region.
Compared to the United States, non-listed real-estate funds from the Asia Pacific region continue to do well. Europe has lately been catching up.
Sources: ANREV, INREV, NCREIF as of 10/2017
Investors appear to have allocated less than their target allocations to global real estate. The gap is especially large for European investors.
Sources: Investor Intentions Survey of PREA, INREV and ANREV as of 1/16/18
* Target allocations are weighted based on real-estate assets. No assurance can be given that target allocations will be reached.