Real Estate Summary

Edition 2, 2018

Emphasize asset management amidst

higher volatility and slightly slower growth

04 Global 10 APAC 16 European 22 US

overview summary summary summary

UBS Asset Management

Content

04 10
Global overview APAC summary

Our research team

Brandon Best
Melanie Brown
Adeline Chan
Christopher DeBerry
Kurt Edwards
Nicola Franceschini
Kara Foley
Zachary Gauge
Tiffany Gherlone
Paul M. Guest

2
16 22
European summary US summary

Gunnar Herm
Fergus Hicks
Samantha Hartwell
Amy Holmes
William Hughes
Alex Leung
Declan O'Brien
Joshua Rome
Sean Rymell
Laurie Tillinghast
Shaowei Toh

3
Global
overview
4
The global economic backdrop is supportive of real estate although
growth has eased slightly. Central bank policy is diverging as the US leads
the way with rate rises. Strong occupier and investor demand has fueled
outperformance of industrial property and we expect this to continue into
2019. Some investors looking to alternatives and value-add to boost
returns.

5
Real Estate Summary
Macroeconomic
overview
The global economic backdrop remained broadly positive in
the first quarter of the year as the synchronized upturn of
2017 continued. However, economic data did soften,
particularly in Europe, and initial Q1 growth figures have been
weaker than Q4. The Eurozone as a whole reported growth of
0.4% compared to 0.7% in Q4. The weakness follows a
strong end to 2017 and may reflect concerns over a global
trade war following Donald Trump's implementation of tariffs
on steel and aluminum in March along with other proposals.
The tariffs are aimed at making good Trump's election pledge
to curb the US trade deficit with China, and were greeted by
the Chinese with potential retaliatory measures. However, in
May China agreed to take measures to reduce its trade surplus
with the US, reducing the potential for a full blown trade war.
Unemployment rates in the US, UK and Japan are at record
lows and continue to fall across the Eurozone. Inflation in the
US is near its 2% target while in Europe and Japan it is below
what policymakers are aiming for. Headline inflation rates may
come under some upward pressure from the sharp pick-up in
the oil price since the start of this year. Efforts by Russia and
OPEC to cut back production, along with worries over supply
from Iran, saw the Brent crude price rise above USD 70 in
April and annual price growth rose above 50% in May.
A notable feature of the year to date has been a return of
volatility in financial markets following a prolonged period of
calm. In January, already at elevated levels, stock markets got
nervous about inflation and prospective interest rate rises as
US wage growth showed a slight spurt. As a result, faster
wage growth was revised lower, with the latest figures
showing annual growth of 2.6% in April. Typically equity
market volatility spills over to the listed real estate sector, but
has little impact on private real estate markets.
Chart 1: Equity market volatility and prices
(Indices)
50
40
30
20
10
0 1400
2015 2016 2017 2018
CBOE Vix Volatility Index (LHS) MSCI World Equity Index (RHS)
Source: Thomson Datastream; May 2018
Edition 2, 2018
More volatile markets made it a difficult yet crucial time for
Jay Powell to take over as Fed Chair. However, so far the
transition seems to have gone smoothly and the Fed pressed
ahead with a widely expected rate rise in March. Setting policy
will remain challenging as the Fed continues to normalize
rates, with the next rise expected in June. Moreover, central
bank policy is diverging around the world with the Fed
pressing on with rate increases, the Bank of England delaying
a rise until later in the year and the ECB staying its hand over
weaker data. The Bank of Japan is the outlier, continuing with
large scale asset purchases and has dropped its target of
returning inflation to 2% by 2019 in preference for an open-
ended time-frame.
Following the current period of reasonable growth it is natural
to expect some slowdown in the economy and, as the adage
goes, economic recoveries do not die of old age. Rather, they
are normally cut short by policy-induced slowdowns to rein in
inflation or external shocks such as the bursting of credit
bubbles. The key questions now are when the eventual
slowdown will occur and whether it will be gradual or
precipitous. Naturally, we think the former would be less
disruptive for real estate markets, while the latter could create
some significant challenges with negative repercussions.
Several factors could be the source of a sharper downturn.
One is the potential for the US economy to overheat given its
unemployment rate is already below 4% and the lowest in 18
years. Donald Trump's USD 1.5 trillion fiscal stimulus is
boosting demand while his restrictive trade policies will reduce
supply. The combined squeeze may ramp up inflation and
force the Fed to raise rates more rapidly than expected and kill
the recovery. Although such a scenario is not our base case,
we see it as the most likely disruptor. A second area of
concern is debt levels, as highlighted by both the IMF and
World Bank, with ongoing fears of a credit bust in China.
Higher levels of corporate debt are a risk, with concerns over
household debt in countries previously thought safe such as
Australia.
Political machinations can also interfere with markets and the
economy, but tend to have a more muted influence than
originally expected. US mid-term elections loom later in the
year and will provide a score-card for Donald Trump's
administration. More worryingly, the West's relations with
Russia have reached a new low following the murder of a
former Russian spy in the UK, for which the international
community blames Russia, and Russia's support for the Bashar
2400
al-Assad regime in Syria. A more positive development has
been the rapid turnaround in relations between the West and
2200
North Korea, which started as South Korea hosted the
Olympics in February. The North Korean leader Kim Jong Un
2000
subsequently travelled to Beijing to meet the Chinese premier
and a summit with Donald Trump is planned for June in
1800
Singapore.
1600
Overall our main message is that the global economy is in
reasonable shape and continues to grow. This is in line with
expectations and positive for real estate markets. Risks are
present, some of which we have outlined, and we will
continue to monitor for emerging threats.
6
Real Estate Summary Edition 2, 2018

Capital markets
Mirroring the reasonably healthy economic backdrop initial
data showed that real estate markets continued to perform
well in Q1. The NCREIF US all property NPI showed a 7%
annualized return and the MSCI-IPD UK direct all property
index recorded an 8% annualized return. Preliminary data also
showed that underlying investment activity maintained a
reasonable pace with little change from Q4. A lack of sellers
continues to hold back activity in some markets.
Industrial has been the clear outperformer over the past
eighteen months and for 2017 as a whole, industrial returns
reached double-digits in many markets. In the US, for
example, industrial recorded a 13% return according to
NCREIF data, while UK industrial achieved a 20% return
according MSCI-IPD. The rapid rise in values has been driven
by strong investor demand and rental growth and has gone
hand-in-hand with significantly higher investment volumes.
Global industrial investment volumes rose a massive 39% in
2017 in US dollar terms, compared to a mere 5% uplift for
offices and 9% fall for retail.
Perhaps a greater danger comes from the potential for
regulation and that the sector could be a victim of its own
success. For example, some traditional retailers are already
calling for a "parcel tax", while environmental and traffic
congestion considerations could see moves to restrict delivery
vehicles which could interrupt last-mile delivery networks.
The supply-side of the market also presents a threat since
logistics facilities can typically be built rapidly. For the time-
being we do not think that supply will hold back rents. Rather,
if anything, in many markets supply is catching up with
demand. Urban logistics facilities are competing with other
land uses such as residential and other property types, with
the focus being on using land as efficiently as possible. For
example, in London plans have been announced for the first
three storey last-mile logistics facility.
Chart 2: Global top quartile commercial and industrial
cap rates and spread
(Cap rate % LHS, spread bps RHS)
10 200
8 150

Industrial volumes were boosted by portfolio level deals, such

6 100
as the USD 14.6 billion purchase of Blackstone's Logicor
portfolio by China Investment Corporation. However, even
excluding this mega transaction, industrial volumes still rose 4 50
23% in 2017. Moreover, the underlying tone of the industrial
market has been positive and one favored by investors, with
value rises alone giving a significant boost to investment 2 0
volumes. Strong investor demand has seen industrial cap rates
and yields show a steady decline in recent years. Data from
0 -50
RCA show that the global industrial top quartile cap rate is
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
now around the same level as the global all commercial top
quartile cap rate. Similarly, the UK MSCI-IPD industrial yield Spread (RHS) Commercial (LHS) Industrial (LHS)
was just 11 bps above the all property yield at the end of
2017 compared to a 147 bps gap in 2010. Sources: RCA; UBS Asset Management, Real Estate & Private Markets (REPM); 1Q18

Overall we remain positive on industrial property going Overall we think that the stronger returns from industrial will
forward and our return forecasts show it as the best continue through the remainder of the year and into 2019,
performing sector over the next couple of years. Markets but that in the medium term the strong outperformance will
where online sales are less developed, such as Australia and eventually come to an end. As for other property types, we
some European countries, have the potential for higher expect industrial returns to slow moving into 2019.
returns as their logistics sectors evolve. Although our view on
the sector is positive we are also wary of it becoming
overvalued and conscious that its growth and valuations must
be supported by underlying fundamentals.

Ultimately the robustness of the industrial story depends upon

the durability of underlying rent flows and it is worth
considering the risks to them on both the demand and supply
sides. On the demand side a key risk is anything which could
cause a set-back in the rapidly growing on-line retail
distribution model. However, with strong and growing
consumer appetite for the convenience and value that on-line
retail offers, fueled by constant technological advances, such a
threat seems unlikely.

7
Real Estate Summary Edition 2, 2018

Strategy viewpoint
We remain positive over prospects for real estate markets but
are aware of potential risks. The period of rapid capital value
uplift driven by yield compression is now behind us, with
income set to provide the bulk of returns. The speed of
interest rate rises and differences between central banks
remain a key focus for investors. With slower property returns
expected following several good years some investors are
looking to value-add and seeking opportunistic strategies to
boost returns. These strategies can complement a core
portfolio but investors must remember they are higher risk.
We think that specialist and alternative sectors supported by
fundamentals can also provide good opportunities.

The logistics and retail sectors continue to experience

significant structural change stemming from increased on-line
sales and sentiment on retail is very cautious. Risks seem tilted
to the downside, particularly for high streets in smaller towns
and for secondary grade, non-dominant shopping centers.
Ultimately surplus retail space will need to be repurposed to
other uses such as logistics or residential. This will create
opportunities for investors, but careful strategic planning for
individual assets will be essential for success.

Offices are more steady, but still subject to their own

structural change due the advancement of flexible workspace
operators and flexible working technology. Overall, for a core
real estate portfolio we recommend a slight overweight to
industrial and underweight to retail. As ever, the general
principle of diversification of risk across sectors and
geographies should serve investors well.

8
Real Estate Summary Edition 1, 2018

9
APAC
summary

10
Real Estate Summary Edition 1, 2018

Near term risks to trade conditions may threaten growth. Robust

economic performance a boon for office take-up across the region.
Ongoing positive transactional activity in commercial property this
quarter. Political and corporate developments in mainland China to
impact Asia real estate markets.

11
Real Estate Summary
APAC summary
Demand & Supply
While the good, export growth-aided times mostly continued
to roll throughout the Asian economy in 1Q18, the
momentum threatened to be halted by the prospect of a trade
war between the US and China. But this, fortunately, appears
to be easing at the time of writing. The fears of a reversal of
globalization, which have been lying dormant since late 2016,
threatened to come to the fore again when the US fired the
first salvo on 8 March 2018, with an intention to impose
tariffs of up to 25% on steel and aluminum imports. This
appeared to be primarily directed at China, the world's largest
steel exporter, especially as that was swiftly followed by an
announcement of new tariffs on USD 50 billion in Chinese
imports, with a possibility of upping that to USD 150 billion.
Tensions appear to have eased for now with the consensus
sentiment being that both sides will negotiate a more
peaceable, less disruptive outcome. But the episode highlights
the reliance of Asia's recent GDP run-up on trade, and how
quickly that could unwind should a trade war break out,
particularly for export-dependent countries like Singapore and
Hong Kong (Chart 3).
Chart 3: Exports
(% of GDP, 2017)
160.0
120.0
80.0
40.0
0.0
Hong Kong Singapore China Australia Japan
Source: CEIC (data as at 2017)
Export growth will likely continue to support near-term GDP
growth for most countries in the region, but we note that it
may be slightly tempered for the rest of 2018 given the high
base in 2017 as well as a normalization of the global
electronics cycle, as indicated by a recent softening of the
semiconductor book-to-bill ratio.
Notwithstanding the impact of a potential trade slowdown,
China's 1Q18 GDP held steady from 4Q17 at 6.8% year-on-
year (YoY) in spite of expectations of a slight moderation.
Household consumption improved, and reduced infrastructure
investment was offset by stronger services investment,
particularly in the education, healthcare and culture segments.
Despite a slowdown in property sales, property investment
Edition 2, 2018
rebounded in 1Q18, due in part to an increase in land prices.
This did not prevent a continued slowdown in the housing
market amidst tighter mortgage conditions.
Australia's economic performance is also likely to come in at a
steady pace in 1Q18 as early indicators point to sustained
strength. Healthy business activity is also expected to bolster
growth for Australia in 2018, while the Reserve Bank of
Australia is likely to keep rates on hold in the absence of
inflationary pressures. The run-up in the labor market,
however, appears to be stalling – after a record 12-month
gain of 415,000 jobs in 2017, the momentum has slowed
with a contraction of 6,000 jobs in February and a meagre
5,000-job gain in March. With still significant spare capacity in
the labor market and the unemployment rate refusing to
budge at 5.5% in March, this suggests limited wage growth
in the future and consequently, limited support for consumer
spending.
Japan's longest economic expansion run in 30 years looks set
to continue in 1Q18, similarly supported by positive sentiment
among the corporate sector. The all-enterprise business index
in the Bank of Japan's Tankan survey continued to pick up in
March, in spite of recent bad weather (which disrupted
business activity), yen strength (which appears to have
reversed at the time of writing) and financial market
instability. While wage growth is not spectacular (with
monthly cash earnings posting an average year-on-year gain
of 1.1% in as at February 2018), there are early signs that the
recent labor market improvement is translating to increased
consumer spending. Retail sales saw positive, albeit mild,
growth in the four months to February, the longest spell of
retail sales expansion since 2015.
Singapore and Hong Kong have both been beneficiaries of
strengthened external demand. Preliminary GDP figures for
Singapore show growth of 4.3% YoY in 1Q18, which marks
an acceleration from the 3.6% annualized growth in 4Q17
and full-year 2017. While performance has largely been driven
by manufacturing and exports, growth is expected to broaden
out to the services sector over the course of 2018. Hong
Kong's economy has already been bolstered by strong
domestic demand, while fiscal stimulus as announced in the
recent Budget will be an additional growth driver for 2018.
Industrial
Ecommerce and the corresponding rise in demand for logistics
space is generating investment demand in industrial
properties. In Sydney and Melbourne, yields have compressed
to record lows while Singapore has also seen a flurry of deals
in recent times, and the strong performance of markets in the
region lives up to the bullish investor sentiment.
Some of the strongest rental gains this quarter are seen in
Sydney and Melbourne, where rents rose 3.9% and 5.5%
YoY, respectively. Decreased supply and healthy demand have
resulted in vacancy rates falling to a cyclical low in Sydney,
and limited new supply in Melbourne will keep the rental
outlook buoyant for these two markets. Landlords are similarly
in a sweet spot in Hong Kong, with strong exports and steady
12
Real Estate Summary Edition 2, 2018

demand from third party logistics (3PL) companies resulting in
robust take-up. The vacancy rate of warehouses remains low
and rents edged up in 1Q18. There is market talk of a
relaunch of the industrial redevelopment program which, if
materializes, will result in stock removal and will further shift
the demand-supply dynamics in landlords' favor.
China in 2018 but with the growth of the middle class and
changing dynamics between online and offline shopping, the
retail scene will continue to evolve. Limited supply in prime
areas in Sydney and Melbourne will drive rental gains but the
same cannot be said for sub-regional shopping centres, which
continue to experience store rationalization.

Large, multi-tenanted warehouses across Greater Tokyo Tokyo continues to face some challenges despite the increase
received record net absorption but this was more than in inbound visitors and their spending per capita. Leasing
matched by record new supply in 1Q18. While the 7.2 million activity remains muted due to a lack of wage growth and high
square feet that came onto the market represents the peak in rent levels which deter some retailers from proceeding with
quarterly new supply, the next few quarters will still see store expansion plans. In recent months, however, there has
significant completions. These, however, are not evenly been some indication of a recovery in demand among luxury
spread; inner areas such as Tokyo Bay enjoy low vacancy rates brands and rents could bottom later in 2018.
and continued occupier demand while the Ken-O-do area will
continue to have vacancy rates that far exceed the other areas
(18.9% vs 6.9% in the overall market as at 1Q18). Chart 4: APAC CBD prime office rent growth
(% p.a.)
High quality business parks in Singapore continued to draw Seoul
Singapore
demand from technology and financial services sectors. With Tokyo
there being no new supply for more than a year now, rents in Hong Kong
the more desirable City Fringe locations ticked up for a third Guangzhou
consecutive quarter and limited pipeline supply will likely Shenzhen
Nanjing
support further rental growth in the near term. In China, Beijing
Shenyang
rental growth is still strong in Tier 1 cities, but landlords have Shanghai
Tianjin
relatively limited leeway to raise rents as occupiers tend to be Wuhan
Chongqing
cost-conscious.
Melbourne
Sydney
Retail Brisbane
Perth
Better economic conditions, tightening labor markets and (15) (5) 5 15
improved consumer confidence bode well for the retail market
1Q17 1Q18
and some signs of life are starting to emerge in a sector that
has otherwise been battered by structural changes in Source: CBRE, 1Q18

consumer behavior.
In Hong Kong, a resilient domestic market, a recovery in
inbound visitor arrivals and increased spending during the
festive season boosted retail sales. This, together with the
recent downturn in rents, has prompted a rise in enquiries by
retailers. In a reversal of fortunes, watch and jewelry tenants
appear to have made a comeback and were particularly active
in 1Q18. Overall high street rents rose by 0.3% quarter-on-
quarter (QoQ) after a 13-quarter downturn and the outlook is
bright given steady local consumption. Confidence is also
returning to the retail market in Singapore with leasing activity
seeing a pick-up. There are signs that the market has
bottomed and both the prime and suburban submarkets
recorded rental upticks after multi-year declines.
The retail market in Shanghai continues to see rents recover,
and main pedestrian street Nanjing Road East saw the vacancy
rate drop amidst strong occupancy. Decentralized areas have
seen supply increase over the past two years but given the
presence of online companies and their growing forays into
the physical retail space, the decentralized areas in Shanghai
could become a testbed for retailers to experiment with omni-
Office
Positive economic performance in the region similarly was a
boon for office take-up in the region. Singapore was a
standout performer in 1Q18 with an 11.1% YoY increase in
rents (Chart 4). Leasing momentum was strong, evident in the
high pre-commitment levels seen in upcoming projects both
within and outside the CBD. Demand in the quarter came
from insurance, transportation and oil & gas sectors and co-
working operators. Rents are still in the relatively early stages
of an upcycle but we note that the issue of secondary space
has largely been ignored by the market for now and may
eventually crop up once tenants start physically relocating.
Chart 5: APAC CBD office vacancy rates
(% of existing stock)
45
30
15
0
Brisbane

Beijing

Qingdao

Shenyang

Tianjin
Chongqing

Tokyo
Sydney

Perth

Nanjing

Chengdu

Seoul
Dalian

Wuhan

Hong Kong
Melbourne

Ningbo
Shanghai
Guangzhou

channel offerings. The integration of online and offline retail

Singapore

appears to be even more apparent in Beijing with take-up in

1Q18 coming from online players opening physical stores. A
4Q17 1Q18
large amount of new supply is expected to enter the market in
Source: CBRE, 1Q18

13
Real Estate Summary
Leasing activity was similarly strong in Hong Kong and was
centred on the decentralization theme amid limited availability
of space and high rents in Central. Rents rose in all sub-
markets and the uptrend is expected to continue this year
with positive economic prospects likely to support leasing
demand.
In Japan, Tokyo rents managed a marginal 0.1% QoQ rise in
1Q18 as strong corporate earnings boosted take-up rates but
there were early signs that the market may soon feel the
impact of impending Grade A supply, with longer rent-free
periods granted to large occupiers. The Australian markets
continue to be split; Sydney had the strongest rental growth
as stock withdrawals and tight vacancies drove prime net face
rents 3.1% higher QoQ in the CBD. Melbourne similarly saw
rents rise and while Brisbane and Perth are still
underperforming, there are signs that the rental downturn
may be bottoming for both amid improved economic
conditions.
Demand in Shanghai is healthy but substantial pipeline supply
in 2018 could cap rental increase this year (Chart 5). In the
medium term, Shanghai will benefit as China pushes ahead
with liberalization of the financial sector. In Beijing, leasing
demand remained strong in 1Q18, supported by technology
firms amidst the government's push for technological
innovation. Financial Street remains the most stable precinct
but with new supply concentrated in non-prime areas, some
decentralization might take place in the coming quarters.
Capital markets
After achieving an all-time high in 2017, preliminary data from
Real Capital Analytics (RCA) suggests that transactional activity
in commercial property (excluding sales of development sites)
in Asia Pacific continued its positive momentum in the first
quarter of 2018 (Chart 6). In terms of composition, activity
was focused on the commercial real estate markets of Japan,
Hong Kong and China.
Transactional volumes for income producing commercial
assets in China were approximately 5% lower in 1Q18
compared to 1Q17. Hong Kong saw a 150% increase in
volumes year-on-year, while Japan transaction volumes also
surged by approximately 40% in the same period. In the case
of Hong Kong, volumes this quarter were propped up by the
USD 3 billion portfolio sale of 17 retail assets by Link Reit to a
consortium. Also of significance were two major commercial
transactions; namely the W Square and 18 King Wah Road, of
which we estimate yields to be at or around 2%. In particular,
the presence of Chinese capital continues to be felt in Hong
Kong and we expect that to intensify in the next two years.
As we engage with investors and market players, it is very
clear that Australia continues to attract significant investment
interest. However, volumes have stayed steady compared to
the same quarter last year. With pricing tightening in the key
Edition 2, 2018
cities of Sydney and Melbourne, alongside solid occupier
performance, it appears that existing owners are reluctant to
sell given the costs involved and lack of alternative
investments for recycled capital. In Japan, several major
commercial deals were transacted in Tokyo in this past
quarter, despite talks of an impending office supply influx.
Unsurprisingly, domestic capital continued to dominate in the
Tokyo investment market and that is unlikely to reverse in the
near term.
General expectations are that the yield compression story
across major APAC markets will come to an end soon.
However, we struggle to pinpoint when that turning point
might be. In the tier one cities of China, such as Shanghai and
Beijing, the inward shift of domestic capital has resulted in
yields that are at historical lows, and spreads that are even
negative in extreme cases. The situation does not seem to be
finding relief anytime soon.
In Singapore, we have observed a clear divergence between
the occupier market and investment market. In the period
before 2017 when the office market in Singapore started to
stir to life, rents were in steady decline but prime yields
continued to compress. Much of the yield compression was
due to the uplift in valuations arising from significant
purchases by high net worth individuals and sovereign capital,
where the key investment goal was typically capital
preservation with limited risk. Singapore fitted the bill very
well, and in this cycle where rents are starting to see a
recovery, we would not expect yields to come off either.
In markets such as Japan and Australia, yield spreads relative
to long term bond yields remain relatively attractive,
theoretically extending the runway for further cap rate
compression in the next few years, at least. Even if inflation
finds its footing and we see rents improving, the weight of
capital will, in the short term at least, continue to exert an
overwhelming influence on expected returns.
In this regard, we believe that expected returns are set to be
slightly lower for new capital buying into today's market,
particularly given the lack of forced sales and the risks for
existing asset owners in reinvesting capital to achieve the
same expected return, either domestically or globally.
Chart 6: Commercial real estate transaction volumes
(USD billion)
15
12
9
6
3
0
Australia China Japan HK Singapore Others
1Q17 1Q18
Source: RCA as at 1Q18
14
Real Estate Summary
Strategy viewpoint
In this edition, we turn our focus to China which has
dominated the headlines for most of the first quarter of 2018.
Most Asia economies ended 2017 with stellar report cards as
the recovery in global demand directed a synchronized uplift
in economic growth across the region. Importantly, China was
a key influence with robust growth in domestic demand
underpinning a revival in imports from Asia throughout 2017.
As we alluded to in our earlier editions, the dominance of
China as a key player in the global economy in recent years
has 'regionalized' and ring-fenced Asia's trade and capital
reliance, weaning Asia off its dependence on non-Asian
foreign capital. It is just as true in the area of real estate
capital flows. These factors make China arguably the most
important actor and stakeholder in Asia, and it is timely that
we examine the possible impact from recent political and
corporate developments in China.
The first session of the 13th National People's Congress (NPC)
was held in early March 2018 at the Great Hall of the People
in Beijing. This annual NPC session is widely watched for
glimpses of and nuances in Beijing's policy stance and possible
policy changes in China. There are a few takeaways that
matter.
Firstly, as China refocuses on the quality of growth over the
quantity of growth, we are seeing a gradual slowdown in the
GDP growth figures. In the recently concluded NPC session,
Premier Li Keqiang announced China's growth target for 2018
at around 6.5% which is unchanged from 2017. In fact, China
had a terrific year in 2017, clocking a 6.9% growth rate.
Obviously sceptics remain doubtful as to the China GDP
figures but in the absence of alternative measures, the GDP
numbers do provide a continuous sense of the ebb and flows
in the real economy. Having surprised on the upside, the
minimum GDP growth now required to meet the
government’s long-term goal of doubling GDP between 2010
and 2020 is 6.3% p.a. This means that China can now afford
to focus on its reform goals and deleveraging, and we do not
expect real estate investment and construction to feature
highly in the growth inputs. At the very least, the age of
highly speculative real estate investing is behind us.
Secondly, China has endeavoured to keep macro conditions
stable, as it continues to pare down debt levels while
maintaining overall economic growth. Anecdotal evidence and
our ground checks suggest that financing channels for real
estate have become increasingly limited since 2017, as
commercial banks come under pressure by the regulators to
increase scrutiny on real estate related loans. In the
opportunistic space, there are some opportunities for investors
to take assets off the balance sheets of cash-flow constrained
developers or landlords. We have also seen some interest by
foreign investors looking to provide private debt or mezzanine
financing to cash strapped domestic property players.
Thirdly, 2018 marks the 40th anniversary of China's "Reform
and Open Up" (改革开放) policy and Beijing is likely to want
Edition 2, 2018
to make significant gains in the modern reform agenda this
year. Supply-side reforms, in the China context, refer more to
the elimination of excess capacity than plainly the reduction of
taxes in Western classical economics. What that means is
China will deepen state-owned enterprise reforms, expand
pension and healthcare insurance coverage to ensure better
labor mobility, and also make further headways in the
legislation of a nationwide property tax. The amplified
liabilities associated with the expanded pension and insurance
systems will indirectly drive pension funds and insurance
companies in China towards higher yielding alternative
investments such as real estate, both domestically and
internationally. It is hardly an exaggeration to say that Chinese
capital is lining up at the gates, waiting for greater clarity and
permission to invest outbound. The recent corporate takeover
of financially troubled Anbang Insurance, however, sent a
clear message that the newly merged banking and insurance
regulator, China Banking and Insurance Regulatory
Commission (CBIRC), will not allow any reckless and
aggressive capital outflows into non-productive and non-
strategic sectors, or risk having any major financial fallout
jeopardize China's deleveraging efforts. We believe the
corollary of this is an increased inward looking real estate
sector, as domestic capital jostles with foreign investors for a
piece of the core real estate pie. To the extent that outbound
capital flows are permitted, markets which fall within the
scope of the Belt & Road Initiative will be given greater
priority. Hong Kong, being seen as an extended market of
mainland China as well as offering investors a natural currency
hedge, could be a key beneficiary of any limited outbound
capital flows. To that end, we can expect yields in Hong Kong
to harden further in the next year, despite being at almost
record lows.
The recent trade skirmish between China and the US warrants
some attention here. When the US fired the first salvo during
the early part of 2018, the situation appeared to be somewhat
dismal. However, we would hesitate to assume the worst.
China has been very restrained in her response, and we expect
that negotiations will instead be the preferred outcome for
both sides. In fact, at the time of this writing, both China and
the US have come to the negotiation table and the ensuing
trade talks are looking more positive than previously expected.
There has not appeared to be any knee-jerk reaction or impact
on commercial real estate in the region, although real estate
markets in Korea and Taiwan, which are tightly embedded in
the China-US supply chain, might face some immediate
pressure in the short term if trade negotiations fail. In the
alternative scenario, while unlikely, China can also resort to
non-tariff retaliation such as curtailing the movement of
tourists and students to the US, or imposing administrative
measures on US companies' direct investments in China. In
the worst case scenario, a once-off devaluation of the RMB
would send ripples throughout the region. In all these
scenarios, Asia Pacific is unlikely to remain unscathed.
All eyes are on China this year and for good reasons. We
advocate that investors in APAC continue to be nimble and
maintain a watching brief on key developments in the region.
15
European
summary
16
Economic data has come down slightly from heightened levels. Tenant
demand remains strong as take-up increases further. Investment
volumes moderate slightly following a strong end to last year. But yields
remain stable and show no sign of moving out yet.

17
Real Estate Summary
European Summary
Demand
Following the giddy heights reached the previous year, the
Eurozone economy hit a patch of soft demand in 1Q18, with
growth expected to slow down to around 0.4% (YoY), based
on a raft of soft sentiment indicators. However, while this is
undoubtedly a moderation in growth, the indications are this
is unlikely to be sustained; manufacturing surveys, for
instance, point to capacity constraints rather than falling
demand, while consumers remain bullish in spite of the weak
growth in retail sales. The consumer side is unlikely to
deteriorate further as inflation remains largely subdued and
employment growth continues apace.
Political risk has also declined over the course of the previous
year, with investors more sanguine about events in Europe
and the rest of the world. The market appears to be pricing in
a softer Brexit as the value of sterling has recovered
somewhat, while fears of President Trump initiating a trade
war in Asia have retreated. The situation further improved by
the possibility of a historic peace summit between the US and
North Korea. Though 2018 started with anti-establishment
parties winning the general election in Italy and most likely
forming the new Government, it still early to say whether the
campaign promises of such parties will be fully pursued. If that
happens (even partially) there will likely be fears about a
further expansion of the already enormous Italian Government
debt, with consequent financial instability in Italy and potential
chain effects on the Eurozone markets. Meanwhile, the ECB
appears to have taken a step towards normalization by
removing its pledge to continue with the asset purchase
program. This could affect more countries with a weaker
financial situation, such as Italy. That being said, the Eurozone
remains behind the UK and the US in terms of its key
indicators and we are, as such, not expecting any rate rises
until at least 2019.
Office take-up remains healthy despite appearing to flatten
out. Total European take-up rose by 2.8% on an annual basis,
which- while apparently modest- remains at high levels having
risen steadily over the past few years. UK regional cities saw
big increases, with rolling annual turnover increasing in
Birmingham (93.2%), Liverpool (90.2%), Glasgow (57.7%)
and Edinburgh (56.8%), however as these are small markets a
few deals can cause large swings. Similarly Marseille saw
volumes increase by 81%, while Luxemburg City saw volumes
rise 74% on a rolling four quarter basis. Of the more sizeable
markets, demand was high for offices in Frankfurt (+41.6%),
Madrid (+34%) and somewhat surprisingly Central London
(+15%). Much of the demand in London is not "true" take-up
as it is being driven by the growth in flexible office providers,
such as WeWork. The inflexibility of UK lease structures has
provided a boon to this sector as occupiers are willing to pay
Edition 2, 2018
slightly more to avoid being locked in for 10-year terms with
upward only rent reviews. At the other end of the spectrum,
take-up in Dublin stalled being almost two thirds below levels
achieved in the previous four quarters, while Milan (-11.1%)
and Amsterdam (-14.6%) also saw relatively weak outturns.
Given consistently high levels of demand and low levels of
incoming supply, it is hardly surprising that rental growth
remains healthy across Europe with prime office rents
increasing by 5% YoY across Europe. Much of this is being
driven by strong regional rather than capital cities. Marseille
for example saw growth of 21% on the back of very strong
turnover, while Zaragoza in Spain (23%) and Bristol in the UK
(14%) also saw rental values increase impressively. However, it
wasn't only the regional cities, as Berlin continues its structural
transformation on the back of impressive TMT demand with
prime rents climbing by 12.7%. Brussels also saw rents
increase 10.5% YoY, while Milan saw rents increase by 7.7%.
Chart 7: Aggregate European office take-up volumes
(including Central London)
4,500 14,000
4,000 12,000
3,500
10,000
3,000
2,500 8,000
2,000 6,000
1,500
4,000
1,000
500 2,000
0 0
Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4
2014 2015 2016 2017 2018
Take-up Rolling annual
Source: JLL 1Q18
In the retail sector, consumer confidence remains high in the
Eurozone as the recovery has already driven wage growth in
tighter labor markets, a trend that is expected to continue. An
additional boon is that inflation remains relatively constrained
which will likely support retail sales growth. The UK is a
slightly different story as economic growth and wages have
been muted over the past year, with spending further stifled
by higher inflation following sterling's depreciation. This,
combined with ongoing structural issues related to the growth
of ecommerce has meant UK retailers have endured a tough
start to the year. Several have already sought company
voluntary arrangements, while even some of those who are
more robust have selectively sought to renegotiate leases on
reduced rents or a turnover basis. It appears the demand
balance has very much shifted in favor of tenants, especially
for any secondary assets.
Prime assets continue to remain in demand, however as rents
increased 1.9% to 1Q18 (YoY). We believe cities with high
tourist flows and strong university towns are well-positioned
to benefit from rental uplifts. It is not surprising therefore that
Italian cities Florence (+33.3%), Rome (+17.2%), Verona
(+13.6%) and Milan (+16.7%) all saw strong rental
18
Real Estate Summary
performance in 1Q18. In the UK, regional cities appear to be
offering better performance than the capital as Birmingham
saw rents increase by a third and Scottish cities Glasgow and
Edinburgh saw values increase by 14% and 9% respectively.
At the other end of the spectrum, rents fell in the major
German cities by 4-5% as well as the City of London by
around -8% with affordability concerns likely playing a role.
We are hearing anecdotally that many retailers are taking a
closer look at the profitability of their Central London stores as
high rents are becoming harder to justify in the current
environment; as a result some retailers are looking to assign
leases on Oxford Street and Regent Street.
Chart 8: Consumer confidence – Outlook next
12 months
(Balance – Seasonally Adjusted)
10
5 construction at present possibly in the expectation of a Brexit
0 bonus, while Stockholm currently has the highest levels of
(5)
(10)
(15)
(20)
(25)
(30)
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Eurozone UK
Source: Datastream, DG ECFIN, May 2018
Retail's loss has been to the advantage of the industrial sector
as ecommerce operators, 3PL firms and of course retailers
themselves have been forced to boost their distribution
capacity to try and maintain market share. The positive story is
not only about the internet, as only around 10% of total
logistics activity is ecommerce-related. Another massive driver
has been the growth in global trade, which has grown at
almost double the rate of GDP over the past 20 years. This has
compelled B2B logistics operators as well as manufacturers to
invest to make their network as lean as possible. The relative
weakness of the euro and strong outturn for European
manufacturing has driven this further.
The net effect of these levels of demand has been a 2.3%
increase in pan-European industrial rents. While this may seem
fairly modest compared with the high levels of tenant
demand, it should be remembered that European logistics
units are not generally inclined to rental growth and that
values are still only around 14% above where they were in
2000. The lack of standing availability and strong presence of
purpose built units is one factor which limits growth, as
developers are generally competing for tenants rather than
tenants competing for assets, which limits rental growth.
More significantly, industrial rental growth was higher than
retail.
The exception to this has been urban logistics, where the twin
drivers of requiring space close to population hubs and
Edition 2, 2018
competition from residential has driven double-digit rental
growth. Major cities- particularly London- continue to see a
net loss of industrial land which indicates this stellar growth
could continue, although several recent insolvencies in this
sector serve as a reminder that this growth may hit an
affordability ceiling soon.
Supply
Europe continues to be in the midst of a 'development puzzle'
as the usual link between higher leasing and rents and
accelerated building appears to have broken down.
Stockbuilding remains at very low levels and- in locations
where there is a more active pipeline- the majority of it is pre-
leased. Paris and Dublin are both seeing high levels of
development in Europe. The Swedish capital has seen
incredibly strong rental over the course of 2017, which raises
the possible concern of a supply shock. Both the City and the
West End of London have also fallen down the pack in terms
of development, with new supply seeing good absorption. The
real test will come later, however, as occupiers may move out
of more secondary stock having taken space in a newly
completed scheme. However, these are rare examples and the
majority of major European cities are currently seeing less than
5% of total stock being built out.
As a result vacancy has continued to fall in 1Q18, with the EU-
15 prime vacancy rate now standing at 7.1%, its lowest level
since the financial crisis. However, there remain large
variations by country and city. The German cities remain the
most constricted; Stuttgart (2.1%), Berlin (2.9%) and Munich
(3.2%) are the top 3 tightest markets in Europe. Elsewhere,
the West End in London has seen occupancy hold up despite
concerns over Brexit, with a vacancy rate of just 3.9%. There
are still some cities with above average vacancy. Rotterdam in
the Netherlands has around 16% of space empty, while the
Schiphol area of Amsterdam is still around 11% vacant.
Barcelona and Madrid remain in double digits as do Milan and
Rome, however all of these cities have seen improvements
over the last quarter.
In the retail sector, development appears to have fallen off the
agenda completely as landlords remain concerned over issues
facing the sector and a possible oversupply of retail space. In
Western Europe, very few new shopping centers are being
built although extensions of dominant schemes remain
common, such as the recently completed addition to Westfield
London. A significant amount of refurbishment has been
taking place as well. Recent research into the sector indicates
that the amount of capex undertaken by the largest owners of
retail space has increased strongly since 2013. While these
landlords have generally been successful in moving rents up
with asset management, they have been required to invest
significantly to do so. Going forward, the question will not be
so much where to build retail space, but which locations to
19
Real Estate Summary
convert to other uses. Anecdotally, some landlords are already
exploring schemes to convert city center assets to residential
or edge of town assets to last mile distribution centers.
Once again, retail's loss has been industrial's gain. Industrial
supply is difficult to track as there is no comprehensive data
source, however it does appear that development activity has
trended up in Europe. PMA estimated that at year end 2017
around 10 million sqm was thought to have come on-stream,
a 17% increase on the previous year. Speculative development
activity has been focused on the UK and the Netherlands,
although 2017 it was mostly located in Germany, the
Netherlands, Italy and Spain. By sector, the demand is still
being driven by retailers, who have accounted for almost 50%
of new space developed since 2010. The biggest participants
in 2017 were the major food store groups (e.g. Lidl and
Carrefour), ecommerce retailers (e.g. Amazon, Zalando) and
non-food retailers (e.g. The Range)
Chart 9: Prime rent index (1Q00 = 100)
150
140
130
120
110
100
90
80
1Q08 2Q09 3Q10 4Q11 1Q13 2Q14 3Q15 4Q16 1Q18
Retail Index Industrial Index Office Index
Source: CBRE: 1Q18
Capital markets
Investment markets appeared to take a pause in 1Q18
following a bumper finish to last year, as volumes in 1Q18
saw a like-for-like decline of -2%. This coincides with a
sobering of some of the jubilant economic data and could well
be indicative of investors taking stock of market conditions.
While this is plausible considering the late-cycle dynamics,
there is evidence to the contrary. For instance, real estate
fundraising continued apace in the 1Q18 and most investors
appear relatively bullish on the near term prospects. A further
aggravating factor is that Chinese capital flows appear to have
subsided somewhat as SOEs have been restricted from making
"reckless" investments outside of China. It appears the regime
is keen to encourage inward investment on the One Belt, One
Road project, although there is still a significant amount of dry
powder waiting to be deployed in Hong Kong.
The sectors where the slowdown was most prominent are
fairly predictable. Retail saw quarterly volumes decrease by
13% as investors continue to remain concerned over
Edition 2, 2018
headwinds facing the sector, while Offices also fell back by
6%. The strong areas were industrial which saw an increase of
20% in turnover, while the alternatives also saw volumes
increase by 12%. On a geographical basis, investment in the
core countries has cooled with investors probably being
deterred by elevated pricing. Germany was flat, while the UK,
Italy and France all saw volumes drop off. The Nordics also
saw volumes drop by around 23% as pricing has become
stretched following a few years of strong outperformance.
Spain remains popular, however, as volumes there rose by
about 32% compared with the previous quarter last year.
Ireland saw a stellar increase of nearly 90%, although this is
such a small market where changes tend to be very volatile.
The Benelux countries also saw inflows up by around 18%,
particularly the Netherlands which has seen its outlook
upgraded significantly.
In spite of the disappointing outturn from investment flows,
prime yields continued to trend downwards in the quarter,
albeit at a slowing rate. The pan-European office prime yield
compressed by a further 4 basis points, now standing at
3.82%. At a city level, UK regional cities have had a strong
start to the year as more or less everywhere apart from
London saw prime yields compress by -25bps. French B cities
also saw strong performance as prime assets in Bordeaux and
Toulouse compressed by a further 25 bps. Overall the vast
majority of locations remained flat which is probably indicative
of the elevated pricing levels for prime European assets.
The outlook for capital markets is also relatively flat, with most
of the added value expected to come from rental growth over
the next few years. One area in which there is possible further
capital appreciation are select fringe locations which are
slightly off pitch but well connected have seen a resurgence in
investor interest. This is particularly true of the German cities
where assets are particularly in demand at the moment and
the supply prime stock highly restricted (and expensive!). The
East, South and Eschborn areas of Frankfurt have all seen
investment volumes significantly above their long term
average, as has the south area of Dusseldorf and the south-
eastern periphery of Munich. Secondary markets in
Amsterdam and Oslo have also seen significant inflows. It
remains to be seen whether this is a savvy play or just late-
cycle behavior, but it represents an interesting shift in a
market where investors have long been focused on core
assets.
The biggest risk for current investors is being caught on the
wrong side of the yield gap as government bond yields return
to normal levels. In the US, this process is well underway with
10-year treasuries reaching 3%, although there has as yet
been no noticeable impact on yields. In Europe investors have
slightly more comfort, however, as the ECB is only just
winding down its QE program with interest rate rises not
thought to be in the agenda for quite a while yet. This lend
some encouragement to nervous investors looking at prime
yields of 3% for core assets in A-cities.
20
Real Estate Summary Edition 2, 2018

Chart 10: EU-15 Yield Index Chart 11: European investment volumes
8.00 100,000

7.00 80,000

6.00 60,000

5.00 40,000

4.00 20,000

3.00 -
1Q12 4Q12 3Q13 2Q14 1Q15 4Q15 3Q16 2Q17 1Q18 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18

Benelux Nordics Italy Germany UK

Retail Yield Industrial Yield Office Yield Spain France Ireland Other*

Source: CBRE 1Q18

Strategy viewpoint While this a very compelling story, there are certain aspects of
these sectors investors need to be aware of. Firstly, unlike
offices and retail the majority of alternative sectors are
operating assets, meaning the landlord needs to take more
The growth of the alternative sectors responsibility for the day to day functioning of the business.
While there is a lot of uncertainty surrounding markets, This either means hiring an in-house team with expertise in
investors are all certain about one thing: we are in a very this area or partnering with an operator in that industry
mature phase of the cycle. As explored in the previous section, sector. Investors would therefore need to consider whether
this has prompted some capital flows to more good quality the premium these sectors offer over traditional sectors is
secondary office markets, however investors have also become enough to justify the added cost.
more acquisitive in the higher-yielding alternative sectors.
Secondly, while RCA puts the total share of alternatives as
Investment volumes into alternative sectors increased by over 35% last year, there are big variations in liquidity. For
14% in 2017, having seen large surges the two previous years instance, a significant amount of this total investment
as well. Investment into hotels has been strong as well as turnover comes from logistics and hotels. Whether or not
flows into student housing, both of which have now become logistics remains an alternative is debatable as it is now
institutionally preferred sectors in many European countries. comparable with the traditional sectors in terms of capital
All told, the alternatives are now an established part of the flows, investor composition and pricing levels. Leased hotels
investment set having represented 35% of total transactions similarly have characteristics more akin to the traditional side,
last year, up from just 18% in 2007. such as signing over the operations and yields comparable to
offices and retail. For investors entering the senior housing or
The popularity of the alternative sectors stems partly from a student accommodation market for instance, there would
late-cycle hunt for yield, as their niche status generally need to be serious questions asked about the hold period and
provides a higher income return. However, most of these exit strategy.
sectors also have a compelling case based on structural shifts
in the market. Senior housing is well positioned to benefit Chart 12: Investment in alternative asset classes
from Europe's aging population, while urbanization and (EUR bn)
declining home ownership provide a supportive backdrop for 120 40%
the PRS sector. Student housing taps into popularity of
100
Europe's universities with international students, while a 30%
growth in international travel will most likely boost the hotel 80
sector. Finally, data centers will be essential for efficiently 60 20%
storing and managing 'Big Data', while the shift to
ecommerce has driven the industrial over the past 10 years. 40
10%
These positive tailwinds stand in stark contrast to the 20
traditional sectors, which as a rule are being negatively
0 0%
impacted by structural drivers. As has been well documented, '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17
the retail sector is struggling due to the growth in ecommerce,
Apt/Resi Student Hsg Hotel
while the office sector may be about to undergo a disruption Senior Hsg Logistics Data Center
of its own based on challenges from digitally savvy serviced Other % Total
office providers such as WeWork.
Source: RCA, May 2018

21
US
summary
22
Two years have gone by since US properties transitioned from
appreciation-driven return to income-led return. Capital market
pressures offset by economic optimism. Industrial supply still growing
bolstered by logistics-intensive consumption, while retail must contend
more with new virtual space than brick and mortar developments.
Apartment and office construction to peak in 2018, implying
incremental demand to be more impactful in coming years.

23
Real Estate Summary Edition 2, 2018

US Summary
One of the biggest stories for the first quarter 2018 was the
volatility in US equity markets. A rise in interest rates and
discussions about new tariffs caused two abrupt declines in
the S&P 500, one in late-January and another in mid-March
(Chart 13). While more stock market volatility is likely, we do
not expect any spillover effects to private US commercial real
Real estate fundamentals estate in the foreseeable future. Fundamental growth in
property-level income continues to follow the strong US
economy and labor markets. Historically, the correlation
between stock market performance and private real estate is
low.

Chart 13: Daily S&P 500 and 10-year Treasury rate

(%)
3 5,700

5,600
2.9
5,500

5,400

Daily S&P 500

2.8
Treasury rate %

5,300

2.7 5,200

5,100
2.6
5,000

4,900
2.5
4,800

2.4 4,700
2-Jan 7-Jan 12-Jan 17-Jan 22-Jan 27-Jan 1-Feb 6-Feb 11-Feb 16-Feb 21-Feb 26-Feb 3-Mar 8-Mar 13-Mar 18-Mar 23-Mar 28-Mar

10-year Treasury rate (L) S&P 500 daily (R)

Source: Axiometrics and CBRE-Econometric Advisors as of March 2018. Supply is shown as a completion rate (i.e. completions as a percent of existing inventory). Shaded area
indicates forecast data.

Occupancy rates are high relative to the past ten years and Apartments
now are facing a small degree of downward pressure with Vacancy rates are increasing slowly in the apartment sector,
supply growth matching or exceeding demand across most under pressure from a peak point in new construction. At
real estate sectors. As there is little room to increase 5.5% vacancy remains below the 20-year average of 6.1%. As
occupancy, rent growth is the driving force behind income shown in chart 14, apartment rent growth remains positive at
gains. Economic conditions create some optimism that growth 2.5% in the year ended March 2018 (source: Axiometrics).
will continue to reflect positive momentum for the US.
US homeownership is unchanged at 64.2% during the first
quarter. This is a pause in a two year tend of rising rates of
Chart 14: Property sector rent growth homeownership, a continued upward trend could slow
(%) apartment demand. However, the current strength in the
8 labor market has been high enough to offset changes in
7 homeownership and maintain below-average apartment
vacancy.
Year-over-year change (%)

6
5
Industrial
4
Growth in net rents is strong but decelerating, as new supply
3 begins to increase. Rents grew by 7.1% in the year ended
2 March 2018, the highest of any property type.
1
0 The industrial availability rate was 7.3% in the first quarter
1Q14 1Q15 1Q16 1Q17 1Q18 2018, which is as low as it has been since 1Q01. We
Apartment Industrial Office Retail anticipate 2018 to be another good year for US industrial. As
we progress into 2019, the sector will have to contend with
Source: Axiometrics and CBRE-Econometric Advisors as of March 2018
higher construction levels, chart 15, that could bring strong
rent growth figures down toward inflationary levels.

24
Real Estate Summary Edition 2, 2018

Office
Heading into 2018, deliveries of new office buildings are
increasing especially in tech markets, causing rent growth to
slow faster than other sectors. At 1.3%, office rent growth
underperformed inflation during the year ended March 2018
with slightly lower rents in Downtown locations and 3.6%
rent growth in the suburbs compared to a year earlier.
Average office vacancy increased 30 basis points over the year
ended March 2018. The gap between downtown office
vacancy at 10.8% and suburban vacancy at 14.5% remains
wide. Rent growth trends suggest that suburban offices are
holding space vacant a little longer to achieve growth in rents.
Downtown locations are likely to sacrifice some rent growth
to keep space occupied.
Retail
Retail sales in brick and mortar stores increased by 4.1%
during 2017, nearly twice the rate of inflation. Consumer
spending is up due to increased disposable income and low
unemployment, which should support US retail sales
throughout 2018.
The mall/lifestyle and power center retail segments are facing
higher availability with space-for-lease increasing by 60 bps
and 40 bps to 5.8% and 6.5%, respectively, over the year
ended March 2018. Stability in high-quality properties is offset
by deterioration in others. At 9.4%, availability in
Neighborhood, Community and Strip (NCS) retail is up 30 bps
over the past year with landlords likely sacrificing some
occupancy to grow rents by 2.7%.

Chart 15: Supply trends

(Year-over-year completion rate in %)
2.0 2.0 2.0 2.0
1.8 1.8 1.8 1.8
1.6 1.6 1.6 1.6
1.4 1.4 1.4 1.4
1.2 1.2 1.2 1.2
1.0 1.0 1.0 1.0
0.8 0.8 0.8 0.8
0.6 0.6 0.6 0.6
0.4 0.4 0.4 0.4

0.2 0.2 0.2 0.2

0.0 0.0 0.0 0.0

Apartment Office Industrial Retail
2017 2017 2017
2017
2018 2018 2018
2018
2019 2019 2019 2019
20-year avg 20-year avg 20-year avg 20-year avg

Source: Axiometrics and CBRE-Econometric Advisors as of March 2018. Supply is shown as a completion rate (i.e. completions as a percent of existing inventory). Shaded area
indicates forecast data.

25
Real Estate Summary Edition 2, 2018

Capital markets Real estate debt capital is low cost and generally available, but
not free-flowing, as was the case prior to the last downturn.
Increasing interest rates compress spreads available to lenders
in a competitive marketplace. The spread between property
US commercial real estate is two years into a period of yields and the cost of debt also further compressed in early
sustainable, income-driven returns. Historically, the income 2018. On the whole, US debt markets can be described as
return component has generated 70% to 90% of property- operational, but not excessive, which encourages development
level total return in the US. Unlevered property returns have but not an abundance of supply.
been relatively stable, trending between 1.5% and 2.0% per
quarter since mid-2016. First quarter 2018 saw the NCREIF
Property Index rise by 1.70%, chart 16. Chart 18: Commercial real estate spread
(basis points)
450
Chart 16: US property returns 400
(%) 350
4.0
300
3.5
250
3.0 200

2.5 150
100
2.0
50
1.5
0
1.0 1Q97 1Q00 1Q03 1Q06 1Q09 1Q12 1Q15 1Q18

0.5 Spread (cap rate minus 10-year Treasury rate)

20-year average spread
0.0
1Q11 4Q12 3Q14 2Q16 1Q18 Source: NCREIF Fund Index-Open-end Diversified Core Equity and Moody's Analytics as
of March 2018.
Income return Appreciation return

Source: NCREIF Property Index as at March 2018 Core real estate spreads over the 10-year Treasury rate
Past performance is not indicative of future results. compressed during the first quarter as interest rates rose and
cap rates were flat, see chart 18. While the real estate spread
Transactions volume showed signs of leveling off during the is well-above historic lows, it is already low enough to be
first quarter 2018 with total volume up by USD 7.5 billion putting upward pressure on cap rates. We expect office and
compared to the first quarter of 2017. Markets remain liquid retail to be the first sectors to experience small increases in cap
in aggregate with the absolute volume of sales of rates. Transaction volume is trending lower in each of those
USD 439 billion in the year ended March 2018, chart 17. large sectors.
Broad trends remain similar to 2017 with sales of retail and
office properties decreasing over the year and sales of Long-term interest rates remain low relative to US history but
apartments, industrial and hotels increasing. increased 50 basis points in early 2018. The 10-year US
Treasury rate was 2.4% at the end of 2017 but rose above
2.9% by mid-February 2018 (refer back to chart 13). With little
Chart 17: US transactions movement in cap rates, the upward move in Treasury rates
(USD billions) condensed spreads available in US real estate. Recent spreads
offered by real estate investments are below long-term
500
expectations, representing a change from the wide spreads
that drew capital so quickly in the wake of the last recession
400 and relieving one of the pressures that had been pushing cap
rates lower.
300
A growing economy and tight labor market should continue to
200
generate demand for real estate. Growth in demand and,
subsequently, in real estate income directly offsets upward
pressure on real estate cap rates. Recent economic growth is
100
positive and near the high-end of recent years, US Gross
Domestic Product (GDP) increased by 2.3% during the first
0 quarter 2018, chart 19.
2012 2013 2014 2015 2016 2017 2018
YTD
Office Industrial Retail Apartment Hotel

Source: Real Capital Analytics as of March 2018

26
Real Estate Summary Edition 2, 2018

Chart 19: US real GDP growth The labor market is strong enough and inflation is just high
(%) enough to justify expectations for continuing the Federal
6
Reserve's (Fed) monetary tightening through the balance of
the year. In March 2018, the Fed increased the target range
5
for the short-term Federal Funds Rate from 1.5% to 1.75%.
4

3 Even as capital markets face some pressure on the cost of

debt, fundamental strength in the US economy, labor market
2
and confidence measures support relatively good occupancy
1 rates and continued rent growth in the real estate sector.
0

-1

-2
Strategy viewpoint
-3

-4 We can now look in the rear-view mirror to see the transition

3Q09 2Q11 1Q13 4Q14 3Q16
Quarterly annualized Annual growth
Source: Moody's Analytics as of March 2018
In March 2018, the unemployment rate was 4.1% for the sixth
consecutive month. A tight labor market generally makes it
tougher to fill open positions and eventually should put some
upward pressure on wage inflation. Job growth was lumpy
during the first quarter with a spike in February followed by a
muted March, see chart 20. Over the past year, average
monthly job gains approached 190,000 per month.
The tight labor market is one reason wage growth is expected
to continue to accelerate in the US. Higher wages and
consumer spending should reinforce expectations for more
inflation. Over the year ended March 2018, consumer price
inflation was 2.4% in the US.
1Q18
from appreciation-driven to income-led performance. Chart
16, shows the relative stability in returns since 2016. Investors
should be reassured that slower appreciation was expected
and the transition happened without market disruption.
Today, property values are increasing at about the pace of
inflation. As anticipated, the spread available on real estate
condensed as interest rates have risen. Cap rates are not
currently increasing in most sectors; however, we expect a
small upward movement in cap rates by the end of the year.
Appreciation now relates back to the positive income
generated by properties, as opposed to the heated capital
market conditions the US experienced in 2014 and 2015.
As long-term investors, we take comfort in income-generated
performance. The positive outlook for economic growth
reinforces our view that income should continue to grow
faster than inflation.

Chart 20: US job growth and unemployment rate Current market conditions highlight the benefits of moving
Change in employment (thousands of jobs) (%) investment allocations toward strategic, long-term positions.
Fairly level occupancy rates and moderate rent growth leads us
400 6.7 to conclude that most property sectors are near or moving
6.3 toward equilibrium levels of supply and demand.
300 5.9
With less variance in real estate performance across sectors,
5.5 diversification is only growing in importance. We expect
200 5.1
markets will continue on a stabilized path, which will likely
result in continued convergence in expected performance and,
4.7 relative to past years, limit the investment opportunities that
100 4.3 seem "obvious".
3.9

0 3.5
May-14 Feb-15 Nov-15 Aug-16 May-17 Apr-18

Job growth (L) Unemployment rate (R)

Source: Moody's Analytics as of May 4, 2018

27
 Real Estate Summary
For more information please contact
UBS Asset Management
Real Estate & Private Markets
Research & Strategy
Paul Guest
+44-20-7901 5302
paul.guest@ubs.com
www.ubs.com/realestate
Edition 2, 2018
This publication is not to be construed as a solicitation of an
offer to buy or sell any securities or other financial instruments
relating to UBS AG or its affiliates in Switzerland, the United
States or any other jurisdiction. UBS specifically prohibits the
redistribution or reproduction of this material in whole or in part
without the prior written permission of UBS and UBS accepts no
liability whatsoever for the actions of third parties in this respect. The
information and opinions contained in this document have been
compiled or arrived at based upon information obtained from sources
believed to be reliable and in good faith but no responsibility is
accepted for any errors or omissions. All such information and
opinions are subject to change without notice. Please note that past
performance is not a guide to the future. With investment in real
estate (via direct investment, closed- or open-end funds) the
underlying assets are illiquid, and valuation is a matter of judgment by
a valuer. The value of investments and the income from them may go
down as well as up and investors may not get back the original
amount invested. Any market or investment views expressed are not
intended to be investment research. The document has not been
prepared in line with the requirements of any jurisdiction
designed to promote the independence of investment research
and is not subject to any prohibition on dealing ahead of the
dissemination of investment research. The information contained
in this document does not constitute a distribution, nor should it be
considered a recommendation to purchase or sell any particular
security or fund. A number of the comments in this document are
considered forward-looking statements. Actual future results,
however, may vary materially. The opinions expressed are a reflection
of UBS Asset Management’s best judgment at the time this document
is compiled and any obligation to update or alter forward-looking
statements as a result of new information, future events, or otherwise
is disclaimed. Furthermore, these views are not intended to predict or
guarantee the future performance of any individual security, asset
class, markets generally, nor are they intended to predict the future
performance of any UBS Asset Management account, portfolio or
fund. Source for all data / charts, if not stated otherwise: UBS Asset
Management, Real Estate & Private Markets. The views expressed are
as of March 2018 and are a general guide to the views of UBS Asset
Management, Real Estate & Private Markets. All information as at
March 2018 unless stated otherwise. Published May 2018.
Approved for global use.
© UBS 2018 The key symbol and UBS are among the registered and
unregistered trademarks of UBS. Other marks may be trademarks of
their respective owners. All rights reserved.
28