One might have expected that, following several years of above-average global GDP growth, the world’s outstanding debt pile would have decreased. Well, think again.
At the end of the first quarter of 2018, worldwide debt – including corporate, government, financial and household debt – stood at a new all-time high of $247 trillion, representing nearly 320% of global GDP.
In the US, deficit spending by President Trump has sent government debt rapidly higher. In Europe too, governments have not taken advantage of stronger growth and low interest rates to diminish their debt burden. In emerging markets, debt in countries like China and Argentina remains a real worry for certain investors.
The fear that some governments may either default on their debt or try to erode it via higher inflation is not completely unfounded. That’s why today’s investors are especially attracted by tangible assets that offer predictable cash flows, preferably inflation-proof real assets. Real estate is one such asset class – though it comes in different shapes and sizes.
Investors can buy bricks and mortar or acquire “paper” property via so-called Real Estate Investment Trusts (REITs) – regulated companies that own, operate and/or finance income-producing real estate. Such property can range from residential homes to commercial property and from timberlands to toll roads.
Typical investors are most interested in residential property, particularly if they want to own the bricks themselves. However, as the world was reminded in the wake of the subprime crisis – when the global housing bubble burst in spectacular fashion – even such “traditional” real estate investors need to tread carefully. “Location, location, location” may be the mantra of property brokers everywhere, but the housing market is a lot more complicated than that. Broader supply-and-demand dynamics, interest rates, tax policies, domestic and local regulations, and a host of other criteria all shape a market that is inevitably cyclical.
A fate worse than debt
Global debt levels
Source: Institute of International Finance
As the property market typically accounts for a major share of any economy – and impacts commercial bank balance sheets via the mortgage loan market – regulators and central banks keep a very close eye on it, tightening conditions to prevent overheating through rate hikes or so-called macro-prudential policies.
Despite such actions, some markets could of course overheat and even collapse, as we have seen before in Spain, the Netherlands and elsewhere. Hence, it is vital to vigilantly watch valuations, past price rises, mortgage bond rate evolution, household debt and housing credit as a percentage of GDP. Taking all this into account, the housing market in Australia, Canada and Sweden currently looks anything but cheap. By comparison, Germany and Japan appear to offer better value.
Investing in physical real estate requires a combination of skill, experience and time. It’s not just a matter of regular follow-up with tenants, but also researching and understanding fiscal implications and local market realities. That’s time-consuming and often nerve-wracking, as many have discovered. Nevertheless, capital gains can prove substantial over time, making property an unusually enticing investment opportunity.
REITs can be complementary to investments in physical real estate by providing access to property sub-sectors – including office, retail, industrial and residential, across a range of geographies – that are out of reach for most investors due to the high up-front capital requirements. Importantly, REITs also increase portfolio diversification and reduce the risk that necessarily accompanies investing in just one or a handful of properties.
Given the relatively low entry costs, increased liquidity and diversification benefits, it’s hardly surprising that the global REIT market has exploded from a fairly modest $300 billion in 2003 to some $1.7 trillion at the end of 2017.
Investing in paper real estate can prove no less complex than buying physical property. Both offer diversification benefits and recurring income, and both face a range of potential headwinds, ranging from rising interest rates to increased global economic uncertainty.
The best advice anyone ever provided in this regard? “Don’t wait to buy real estate,” as the American humourist Will Rogers recommended. “Buy real estate and wait.”
Brown Shipley Investment Office
This article appears in our Global Investment Outlook 2019. An indepth look at the key trends and big ideas that will shape the global investment outlook over the next 12 months. Download a copy of this document here.
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