A Tale of Two Real Estate Markets: US and China

Stephen Dover: Tim, in a recent article you wrote, you pointed out that roughly 11% of the assets in the big institutional investors are in private real estate. And of course, other than their homes, most individuals don't have access to that area of investment. As we look into 2022, what is your general outlook for private investing in real estate?

Tim Wang: Our outlook for the real estate market in 2022 is very positive. As you know, demand has been strong, especially driven by the industrial warehouse sector, rental housing, and the life sciences. We're in this inflationary environment. It has been well-documented that commercial real estate can hedge against inflation. And this is because of that landlord has the ability to increase rent under a better economic condition.

So, for that particular reason, institutional investors are increasing their targeted real estate allocation now to over 11% for next year. I think many high-net-worth individual investors are also catching up.

Stephen Dover: Let's talk about the housing sector a little bit, and how you think about that. And I know probably for private investment, it's more multi-housing than individual houses. How do you see that sector growing and where geographically do you see opportunities?

Tim Wang: Based on our calculation, in the United States, we're having a housing shortage. Since the global financial crisis, there's been chronic under-development of housing in general, over the past 10, 11 years. So, we probably have about a 5.5 million housing unit shortage in both for sale single-family homes and the multi-family in general. And you know, we talk about this theme of millennials getting older, they're having families, they're moving to the suburbs. So, that's a great cyclical demand over the next 10 to 15 years.

In terms of geographic theme, we continued seeing the household migration from the more expensive [US] metros, like New York or California, to the less-costly metros, especially in the Sunbelt market. We're talking about Florida, Texas, Phoenix, and the Las Vegas and those places because they are more affordable. Not only households are more relocating over there, but also corporations are following them because they know that's where they can attract and recruit talent.

Stephen Dover: The sharp rise in the housing market  post-COVID is really a global phenomenon in both developed markets and emerging markets, not just in the United States. So Tracy, can you tell us a little bit about the major drivers behind this housing boom, and whether you see risks or even possibly a housing bubble?

Tracy Chen:  So, we have done some comprehensive research on the global housing market. What we found is many countries have double-digit home price appreciation after COVID. I think there are mainly four drivers behind this. The first one is the large accumulation of savings from the central banks’ generous stimulus packages, and also people reassessed the housing space needs during lockdowns and housing becomes not just a shelter, but also an office. Secondly, the historical low borrowing costs, because since central banks are loosening monetary policy by responding to the pandemic and the historical low borrowing cost triggered a housing boom. And thirdly, there is a severe housing supply shortage, and this is global. It's not just in the US. I mean, the US it's mainly triggered by the shortage of lumber, labor, and land. And then, if you look at the construction companies, they are at full capacity. They cannot ramp up their construction activity to meet the demand. And lastly, there is a wall of money chasing those higher-yielding properties. There are a lot of institutional buyers, and the housing boom post-COVID actually triggered some kind of political issue because a lot of buyers, they are priced out of the market, and this will actually exacerbate the inequality problem in the world.

Stephen Dover:  So Tracy, let's turn a little bit to China and of course, China's largest property developer, Evergrande, ran into really serious financial problems. From your looking at global markets in the West and China. How do you see currently the Chinese property market?

Tracy Chen:  The Evergrande crisis is not a surprise to me. There are three drivers behind the Evergrande crisis. One is the Chinese government are trying to de-lever the most highly levered property market because they don't want to be another Japan, and they want to reduce the financial risks.

The number two driver is their goal of common prosperity, and they realized the property market has become so expensive. And that, that also triggered a lot of inequality problems and they want to tackle the three big mountains like housing, healthcare, and education. Those are three big mountains that have been put on the shoulder of households in terms of that burden.

And then the third one is dual circulation, because China wants to substitute the import and to upgrade their value chain to focus on high-end manufacturing. And they want to channel capital away from unproductive sectors, like the property sectors, to more productive sectors. So, I think if you look at, what Xi Jinping has been talking about is housing is for living and not for speculating. And going forward, I think the Chinese property market will be more stable because, policymakers’ goal is all about stability. They want to stabilize housing price, land price, and house price appreciation expectation. So, I would say the very volatile, boom and bust of the property market is behind us, and going forward, I would say this market is more government-driven. And also, government will not use the property market as a tool to stimulate the economy. And, probably we will have a more boring housing market, but at the same time, more stable.

Stephen Dover: And when you look at China and compare that to the United States, how do you see the difference in risks and opportunities between the two?

Tracy Chen: I think comparing the housing market of the two biggest economies is very interesting. I think there’s a lot of differences. First is the size of the housing market. Believe or not, China's housing market is bigger than the US. So, housing is extremely important sector in China because of the size and also the importance to the economy is also standing out. The property sector accounts for about a third of China's GDP, whereas in US and Europe, it's about 15% to 18% in terms of property market as a percent of the GDP. And the homeowner rate in China is as high as 90%, because the privatization of the housing was actually started in late 1990s and previously it's mostly social housing. And in the US, home ownership is about 65%. But, I want to also emphasize, another big difference is the demand-and-supply dynamics. So, in the US, post-global financial crisis, we have a severe shortage of housing because of underbuilding. Whereas in China, we have a moderate oversupply problem because of the fast-paced building post-global financial crisis. And in terms of demand in the US, we have a delayed household formation or home buying from millennials. Those millennials their home ownership is relatively low, I think around 45%; they are lower than the general population. So, I would expect the millennial will push higher home ownership going forward, whereas in China, the housing demand peaked in 2017 because of the aging demographics, and we will see less new marriages, and the housing demand in China will continue to decline.

Stephen Dover: Tim, you've written about many of the benefits of commercial real estate. And one of them you've talked about is income and the growth in income. Can you talk a little bit about how that works with commercial real estate?

Tim Wang: Yes. Commercial real estate generates a good yield on a relative basis. And number two is a diversification, because commercial real estate tends to have low or even negative correlation with stocks and bonds. So, once you put that in a portfolio context, it could generate a diversification benefit for the portfolio.

Stephen Dover: Commercial real estate is actually a very broad sector, and there's lots of components of it. Can you just talk briefly about what sectors you currently like?

Tim Wang: As you know, the pandemic hit the real estate sector hard and the impact on different property sectors are actually very different. Some sectors were seeing these protracted negative impact, but other sectors are actually benefiting from this. On top of this list is industrial warehouses. E-commerce, online shopping, has had a huge boom during the pandemic and then continues on into this year and forward. And also, rental housing is a necessity. So, many households move out of the city into the suburbs because they want a bigger space. They want less density. So, we're having a housing boom across the United States, as well.

And life sciences. Decades of research, right now, have yielded to the commercialization result. We're talking about vaccinations, we’re talking about gene therapy, and so on. All of this has been driving the specialty life science real estate boom, as we speak. So, we're seeing quite a bit of attractive investment opportunities in commercial real estate sector.

Stephen Dover: So, one area people have a lot of questions about is the office space sector, obviously with the work-from-home movement and COVID. The question is whether people will go back. So what's your outlook on the office sector?

Tim Wang: Yeah, there's still a lot of uncertainty because work from home, this theme is still developing as we speak. But our general outlook is that there will be a lot of flexibility going forward. So, people may be working in the office anywhere between two to four days, and the rest of the time from home. So, in the near term, this is a clearly a negative office demand, but over the long-term we think that, given the US population growth, given the continued growth in office using employment, we think eventually demand will catch up over the next few years, and the office is still the place for collaboration, for innovation and for socializing with our clients and colleagues. So there's no replacement for office.

Stephen Dover: One of the big inflations that's talked about a lot is inflation in materials and also just generally in construction costs. How do you think about that, and do you think that's likely to slow down?

Tim Wang: I have to say that it is going to take a while to resolve that because there's just no easy solution to resolve these supply-chain glitches we're seeing in major ports in the US and across the globe as well.

On top of that, this $1.2 trillion [US] infrastructure bill, this very large federal spending over the next five to eight years, going to be competing for material and the construction labor going forward. So, we think the construction material costs and labor costs are going to remain elevated going forward. There's just no easy solution around this.

Stephen Dover:  Tim, this has been a really interesting conversation, so thank you for sharing your thoughts with us on commercial real estate. And I want to thank you, Tracy for covering structured debt, real estate based, all over the world. And I want to thank you the audience for listening to this.

Host:  And that’s it for this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about anywhere else you get your podcasts. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.