Valuation dynamics in the real estate sector

As part of our monitoring of alternative investments, following is an update on the dynamics of the real estate sector. As the third quarter of 2023 progresses, global real estate valuations have experienced a significant correction due to changes in capital market conditions over the past year.

Transaction and investment volumes have declined, reaching levels similar to those recorded during the first quarter of the pandemic, as investors adjust to a higher interest rate environment. Under this context, in the first quarter, transactions totaling US$210bn were completed, representing two-thirds of the long-term quarterly average. In this regard, early signs for activity in April and May confirm that the market maintained low activity.

Valuations and prices have shown three quarters of downward correction in most markets, with the fourth quarter of 2022 being the most pronounced. During the nine months through March 2023, valuations in the MSCI Global Property Fund Index, which represents more than 110 regional real estate funds, declined by an average of -7.5%.

Although the direction of the correction is similar everywhere, there are significant regional differences. The UK market, for example, leads the correction with a decline of more than -22% in the 11 months up to May 2023, while Australia shows remarkable resilience with only a -1% correction recorded in April and May.

This environment of valuation corrections has also made it difficult for fund managers to raise capital. During the first quarter, capital raised in private real estate funds declined 78% compared to the fourth quarter of 2022, with only $12.4 billion of capital committed.

Uncertainty about how much further the valuations in any part of the market will have to be corrected depends on a number of factors, including the future path of interest rates and the local outlook for rent growth, as well as the level of inflation in the global economy.

If the narrative of a “soft landing” for the global economy prevails, real estate investor sentiment is likely to improve toward the latter months of 2023. In such a case, the turnaround in activity is likely to be rapid, as investors will seek to capitalize on an attractive valuation environment.

Source:  RCI, Mercer Global Market Summary July 2023.

Source:  MSCI, Mercer Global Market Summary July 2023.