The surge in inflation at the start of 2024 is beginning to abate, particularly in the US where inflation is back on track to the Federal Reserve's (Fed) target. This trend is expected to lead to interest rate cuts amid signs of a slowing labour market. In the UK, headline inflation fell to 2% in May because of food price disinflation and moderating core inflation. However, underlying inflation pressures remain strong. The Eurozone is experiencing a return to normal levels for energy, food, and core goods inflation, but services prices are normalising more slowly. Japan's inflation is moderating, with core and services inflation running at only 0.9% in quarter-on-quarter   annualised terms. In China, inflation remains tepid, with the headline consumer price index (CPI) at 0.2% year-on-year (YoY) in June. India's inflation is driven by food prices, with headline inflation at 5.1% in June. Brazil's inflation surprised on the downside in June, coming in at 4.2% YoY. While global inflation is in a significantly different place compared with 2022 and 2023, there is a risk of an escalation as potential new tariffs on Chinese goods could push prices higher.  

Global economic activity outlook

US growth is moderating, with consumer spending slowing and non-farm payrolls growth suggesting a robust labour market. The UK's gross domestic product (GDP) grew by 0.4% in May, with real wage growth remaining strong. The Eurozone is expected to deliver moderate growth, supported by solid household consumption and positive real earnings growth, although purchasing managers' indices (PMIs) faltered slightly in June. Japan's economy showed weaker growth over the past three quarters, but business sentiment remains upbeat. China's trade data for June showed falling exports and imports, with GDP growth expected to meet the 'around 5%' target for the year. India's economy is expected to slow in 2024, but still outperform its peers due to structural tailwinds. Brazil's economy avoided a technical recession in late-2023. Momentum picked up in the first quarter of 2024, supported by the strength of the services sector.

Global monetary policy outlook

While it's quite possible that only one cut is delivered, we expect the Fed to cut rates by 25 basis points (bps) at its September and December meetings. This leaves more room for cuts later in the cycle. The Bank of England (BoE) is expected to cut rates in August, provided inflation data cooperates. The European Central Bank (ECB) kicked off its easing cycle in June, with further cuts expected in September and December, taking the deposit rate to 3.25% by year-end. Counter to the cuts emerging elsewhere, the Bank of Japan (BoJ) is expected to announce a gradual reduction in bond purchases and a 10bps rate hike in July. The People's Bank of China set up a new interest rate corridor to anchor short-term money market rates, with little change in long-dated yields. The Reseve Bank of India is expected to maintain its stance until the outlook for food inflation improves, with potential rate cuts pushed into early-2025. The Brazilian Central Bank paused its easing cycle in June, with further cuts expected in the fourth quarter of 2024, as underlying inflation moderates and as expectations for a Fed cut grow.

Scenarios

With uncertainty still relatively high, owing to the vast number of elections and rolling geopolitical tensions, we are using scenarios and probabilities as the best way to plot the course for the global economy. The six scenarios below summarise the potential outcomes and their probabilities, as of June 2024. 

Soft landing (30%): US growth moderates but remains positive, while Europe and China recover. Inflation returns to target, allowing central banks to lower interest rates.
No landing (20%): Robust activity growth causes tight labour markets and inflation pressures. The Fed doesn't cut interest rates in 2024 and may hike again.
Full-fat Trump (15%): A second Trump presidency leads to trade wars, immigration restrictions, tax cuts, and deregulation, causing a significant inflationary shock.
Rolling end cycle (15%): Earlier interest rate hikes lead to a US recession. The Eurozone and UK dip back into recession, and Chinese activity slows.
Supply side uplift (10%): Robust supply growth leads to strong global growth without exacerbating inflation. Central banks ease rates, but higher potential growth means a higher equilibrium interest rate.
Oil and shipping price surge (10%): Middle East conflict causes a surge in oil prices and global supply chain disruptions, leading to higher inflation and potential central bank tightening.

Global economic forecasts

Source: abrdn June 2024 
Forecasts are a guide only and actual outcomes could be significantly different.

United Kingdom real estate market overview

With a majority of around 170 seats, the Labour Party has secured a landslide victory in the UK General Election. For now, attention will turn to the formation of the new government and preparation for the King's Speech, which will take place on 17 July. This will set out the government's legislative intentions for the next year, likely to include planning and labour market reforms.  
As expected, the BoE kept rates on hold at 5.25%, with a seven-to-two vote split at its June meeting. The communication noted that some of the seven voters in favour of keeping rates on hold were close to voting for a cut. We expect the first rate cut in August. However, a decision is highly data-dependent, and it wouldn't take much for an upside surprise in the next round of inflation or labour market data to see the first-rate cut pushed out once again. 
We are seeing initial signs of stabilisation across UK real estate. Declines in capital values across the more favoured segments have slowed substantially over recent quarters. We expect pressure on these segments to subside further following reductions in the policy rate. Out-of-favour segments are expected to see additional declines in capital values, especially as transactions pick-up throughout the year.

According to the MSCI Quarterly Index, all property saw capital growth of -0.6% over the first quarter of 2024, its smallest quarterly decline in two years. Boosted by a resilient industrial sector and supported by retailers and their strong consumer base, overall property values are expected to recover as economic conditions also stabilise. Offices remain the laggard of the index, posting a decline of 1.7% over the same period. Much of this loss in value originates from secondary space, and properties without appropriate environmental, social, and governance credentials and amenities.

Total returns largely flipped back to positive territory over the first quarter of the year. Most segments were positive or close to flat on an annual basis. Offices were the exception at -9.3%, after seeing substantial repricing last year. Strong rental value growth is acting as a bastion for the industrial and residential sectors, registering 6.5% and 6.9% on an annual basis, respectively.

As investors await a more supportive macroeconomic environment, the investment market remains lukewarm. Total transactions over the first half of 2024 were down around 7% YoY to £24 billion, according to Real Capital Analytics. Around 23% of deals were in the residential sector. It remains a favourite among investors, looking for strong rental value growth potential and favourable supply dynamics. Around 18% went to hotels, as North American investors were active in several large portfolios, namely around London. Unsurprisingly, secondary offices remain less popular with investors, given high capital-expenditure requirements for assets struggling with low occupancy. Outside of prime assets, lenders are still hesitant towards the sector, as valuations are correcting.

European real estate market overview

The Eurozone is expected to maintain moderate growth, supported by solid household consumption and positive real earnings growth. Despite a slight moderation observed in June's flash PMI, the general outlook remains optimistic. 

After peaking, energy, food, and core goods inflation rates have normalised. Services inflation, however, is predicted to remain sticky, driven by strong unit labour-cost growth and robust nominal wage data. These factors, coupled with lower-than-expected unemployment rates, suggest that headline inflation may stay above 2% during 2024. This could challenge the Eurozone's disinflation efforts.

The ECB initiated its easing cycle in June, with further cuts anticipated, possibly in September and December. Despite these reductions, this could limit the scope for aggressive monetary easing. The ECB aims to normalise policy towards a suppressed equilibrium rate, without intervening in volatile French markets.

The outlook for European real estate is gradually improving. Nervousness around refinancing challenges has cooled substantially since our last outlook paper, but pockets of distress are filtering out into the market. Challenges also persist in other areas (including geopolitics), and in France where snap parliamentary elections are underway at the time of writing. Yet there are more signs that the market is finding its feet.

In the first quarter of 2024, INREV reported that Europe delivered its first positive quarterly return (0.41%) for seven consecutive quarters. Capital values were still down 0.6%, yet the pace of decline is notably slower and is now being offset by the highest income return in five years for the index. 

We expect returns to improve in the second quarter of 2024, given evidence of stabilising valuations. According to data from CBRE, the share of market segments in its monthly yield sheet that were stable over the three months to June 2024 increased to 86%. This rose from 70% in March 2024. While this reflects prime quality in most cases, and is only indicative market estimates, the sense that valuations are stabilising is growing. 

Gradually cooling inflation and the first rate cut by the ECB in five years have helped. However, arguably the main reason for real estate's improving outlook is because it's performing very well from an operational standpoint. Aside from secondary offices, real estate remains in tight supply and rents are rising. 

According to data from MSCI, European rental values increased by 4.3% across all sectors over the 12 months to the first quarter of 2024. Rents for industrials increased by 6.8%, residential by 6.3%, offices by 2.8% and retail by 1.6%. Cumulatively, all property rents increased by 8.6% since the downturn began in June 2022. After the global financial crisis, all property rents fell by 8.5% before they stabilised two-and-a-half years into the downturn.

Economic growth is a key driver of tenant demand and rental trends. While it currently ebbs and flows more than we would like, the outlook has improved. Composite PMIs remain positive, on average, and labour markets are demonstrating resilience. Unemployment in the EU edged lower to 6.4% in April 2024. Real wage growth in the Eurozone was 5.3% in May, the highest rate since June 2022. These factors are supporting the cyclical recovery in the asset class, more so than interest-rate cuts. 

Supply is the most interesting driver for income resilience and rental growth. The European market has lacked a strong development cycle for over 15 years. Ongoing pressures among developers and contractors suggest this will continue. EU construction new orders fell 18% YoY to May 2024, having fallen by 27% in the first series of lockdowns around May 2020. 

The strength of European real estate cashflows and their growth potential is attracting capital back to core assets. Prime yields jumped 140 bps from a low of 4.3% in June 2022 to 5.7%, on average, in June 2024. Higher yields and the potential for income growth, in the wake of the strong correction in values, now present a compelling entry point for investors. In the latest INREV Confidence Indicator survey in June, sentiment towards core real estate jumped notably from -10% to 15% in one quarter. 

This is reflected in our expected returns for European real estate, with our three-year annualised total return forecast jumping to 9.1% from June 2024, up from 7.5% last quarter.

APAC real estate market overview 

China's 'around 5%' growth target for 2024 remains in sight and incremental easing is likely to continue. Meanwhile, Japan's exit from the 'lost decades' remains half-convincing and the BOJ's approach will likely remain cautious. The Reserve Bank of Australia's balancing act is likely to continue, and most observers expect easing to begin from early-2025. In contrast, the Bank of Korea, which presented a dovish inflation outlook in June, appears on track to cut rates in the second half of 2024.  
A more hawkish assessment of the pace of rate cuts will delay the recovery in Asia-Pacific's (APAC) commercial real estate (CRE) investments. Asset repricing in APAC lags the US and Europe; most markets/sectors are still valued at tight yield gaps, relative to history. Consequently, we have downgraded our outlook for near-term capital returns. We expect a deeper trough and a longer recovery for APAC CRE values. 

Coupled with the growing bifurcation in occupier market fundamentals, we believe bottom-up market and stock selection will be key for investment performance. We prefer strategies targeting offices in Seoul's key business districts, multifamily rental housing in Tokyo, and industrial/logistics (I/L) properties in Australia. We have further upgraded our expected returns for offices in India's key markets, such as Delhi's National Capital Region, to reflect strengthening fundamentals.

Offices in Seoul's key business districts led APAC's investment activity over the year to the first quarter of 2024, supported by solid occupier fundamentals. This is especially the case in the central business district (CBD) and the Gangnam business district submarkets, where vacancy rates remain significantly tighter than historical levels. We expect this to remain the case, even as new supply ramps up from 2026. That said, a slower pace of rate cuts could moderate investment activity in the near term.

Solid occupier fundamentals are supporting investment demand for Australian I/L properties too, with transaction volumes up 36% YoY in the first quarter of 2024. Leasing demand is outpacing supply and vacancy rates remain near record lows of sub-2% in most markets. We have moderated our expected returns for the sector to reflect higher-for-longer interest rates and potential longer-term supply. Occupier fundamentals, though, remain one of the most robust in the region.

We remain bullish on Japanese multifamily properties, especially those within the Tokyo 23 wards. We expect net migration into Tokyo to keep vacancy rates tight and to support further rental upside. This is amid an environment of elevated home prices and limited supply of for-sale units. This is especially the case for single and compact unit types, as foreign nationals and younger migrants represent a growing share of Tokyo's population.

US real estate market overview

The pace of US growth appears to be moving down a gear. Consumer spending has slowed, last year's surprise fiscal stimulus is fading, and investment remains subdued amid high interest rates. These dynamics should persist in the coming quarters, which should translate to an annualised growth rate of 1.5%-2% over the rest of the year.

Office vacancy risk heightened for many major markets, as leases signed before April 2020 approach expiration. Rent declines are expected to persist. We expect a modest outlook in the immediate term for multifamily, as it faces oversupply. We expect one-year rental growth of 1.2%, with supply-constrained east-coast markets delivering better performance.   Rental growth for industrials is expected to moderate, given absorption has slowed to 75% of 2022 levels. Longer term, we expect rental growth for industrials to sit slightly above inflationary levels.

Overall deal volumes in May 2024 measured 37% below previous year's levels. The industrial sector posted the smallest annual decline in sale activity in May, aided by transactions in multiple industrial portfolios, including four sold by Blackstone. On the whole, yield expansion has slowed down, but capital growth remains challenging for the rest of the year.

Smaller logistics and industrial spaces on the East Coast, Gulf Coast and the Midwest should perform well, given the nearshoring/friendshoring trend. The impact of possible strikes at east-coats ports is negligible. Multifamily performance is modest for the year ahead. We expect the East Coast markets to outperform, with a delayed supply response as we head into 2026 driving a strong recovery in the sector  . Views on strip retail remain positive, given the lack of new supply, but real rental growth will be challenging in the longer term.

Global market summary - outlook for risk and performance

As we move further into 2024, we anticipate that the majority of the real estate pricing correction has played out at an all-property level. Indeed, some segments have seen valuation uplifts in the UK and Europe. As a result, the global real estate asset class has been upgraded from underweight to neutral in our June 2024 multi-asset global houseview. While this might seem a modest improvement, the clear message is that it's no longer beneficial to carry an underweight allocation to the asset class. 

Expectations for capital values vary at a sector and regional level, with APAC being on a different path to the others for now. Assets in sectors that are unlikely to benefit from thematic tailwinds remain vulnerable. Poor-quality assets, where future retrofit costs are rising because of more onerous environmental legislation and high construction costs, are also unlikely to perform. We expect further capital decline for these types of assets. 

Although we are more positive about the market's prospects, the expected turning point has been delayed several times by sticky inflation and a hesitancy to ease policy, particularly in the US.

This cycle is notably different from the last because of one key factor: rental growth. In Europe, all property rents fell by 8.5% in the wake of the global financial crisis, yet they have increased by 8.6% since the onset of the recent downturn in June 2022. The pace of rental growth has slowed somewhat in recent quarters. But with supply generally limited, we believe there is strong potential for rents to rise in excess of the long-term average in the coming years.  

Investment activity remains subdued, but there are signs that sentiment is improving towards certain areas of the market. We expect sentiment and activity to improve into 2025. 

We remain very positive about sectors with strong fundamentals, such as logistics, residential and its various subsectors, retail warehouses, and some alternative sectors. Some higher-quality assets in central office segments are also beginning to look better relative value. Vacancies are low in these sectors as is future supply. Demand also remains strong and is benefiting from thematic tailwinds. 

Expected returns are rising. We forecast a global all-property total return of 3.2% over the year to June 2025, and 6.6% and 7% per annum on a three- and five-year annualised basis, respectively. Risks are slowly ebbing and more attractive opportunities are emerging. For those with equity, opportunities to invest at attractive pricing points should emerge this year. 

The UK and parts of Europe are expected to lead the recovery. APAC is experiencing a more muted cycle because of the Chinese real estate crisis and asymmetric Japanese monetary policy. The US recovery appears to be relatively more protracted now, given European central banks are leading the Fed in easing policy. Logistics, alternatives (other) and residential sectors are expected to outperform retail and offices, although retail warehouses and core CBD offices offer better performance within their sectors. 

Strategic outlook

Cycle

The market correction is nearing the latter phases and we expect conditions to improve through 2024. Our three core phases of this cycle remain in place:

• Yield revaluation 

  We believe that the yield correction is roughly 95% of the way through

• Economic recovery 

  Resilience or gradual economic recovery in the second half of 2024 and a bumpy rate-cutting cycle from June 2024 (real estate should react positively to this).

• Supply-driven rental rebound

  A lack of good-quality supply to support materially above-average rental growth prospects. 

Opportunities 

Core / core + / specialist diversified strategies
• Cyclically, a great time to enter over the next 6-12 months.
• Logistics (over-corrected).
• Prime CBD offices (or consolidation to core).
• Living sectors (resilience and portfolio diversification).
• Dominant/grocery-anchored retail warehouses.

Value-add strategies
• Distressed sales still coming through, but secondary pricing has further to move in most cases.
• Office refurbishment where entry yields are more than 7% and location/amenities are strong, plus redevelopment to residential if yields are more than 10%.

Special situations
• Opportunities where refinancing fails, or recaps.
• Corporate buyouts - including real estate investment trusts.
• Developer insolvencies.

Rolling total return forecasts by region and sector, June 2024 (%)

Global sector convictions

Source: abrdn June 2024. Non-risk-adjusted, local currency, absolute returns, excluding transaction fees. Arrows reflect recommended portfolio sector tilts for balanced funds, Q3 2024.

Past performance is not a guarantee of future returns.
Forecasts are offered as opinion and are not reflective of potential performance. Forecasts are not guaranteed, and actual events or results may differ materially.

Global market risk

The abrdn GlobalRiskNavigator measures the comparable risk of implementing a direct real estate strategy across individual or multiple jurisdictions, globally. Lower scores indicate lower risk to the expected outcome. It uses nine sources from our proprietary research, in-house data and from external sources. It has a 50% weighting to environmental, social and governance (ESG) metrics, including measures of climate policy, vulnerability to climate change, social stability and the strength of governance. This gives our GlobalRiskNavigator a strong link to emerging physical climate and transition risks, while also using more traditional risk measures, such as liquidity, transparency, and market size. 

As a mature and relatively transparent market, Europe typically has the lowest country risk scores, with France, Germany and the UK leading the global ranking. The Nordics generally score well on ESG measures, but market size and liquidity risks can weigh on their overall scores. The US has fallen down our overall ranking since the introduction of a greater weight to the five ESG factors. Asia-Pacific has a wide spread in scores across the region, with countries affected by lower transparency, market size, climate risk, and economic risk. More developed Asia-Pacific economies, such as Japan and Australia, have lower risk scores than emerging economies. 

abrdn GlobalRiskNavigator 2024

Author: Leo Morawiecki
Associate Investment Specialist, Fixed Income, abrdn

In this update, we present the quarterly State of Trend report for Q2, 2024. As we publish this report, incredibly volatile market conditions have emerged. With global equity markets falling in recent days, we see value in alternative asset classes. 

Our report covers the performance of Trend Following systems compared with traditional investments such as the S&P/ASX 200 Total Return index, and the Australia "60/40" portfolio. Trend Following provides exposure to a diverse pool of underlying instruments, and implements trading strategies systematically and without emotional biases.

Subdued quarter for trend following systems

Trend following systems were down slightly for Q2 2024, with key trends from Q1 having moderated this period, including in equities. Diversified asset exposure across commodities and currencies helped to buffer performance in the context of what was a "whipsaw" quarter.

Key market movements in Q1 2024

• Q2 2024 was a more challenging quarter for returns, with major equity indices moderating and bond markets continuing to deliver muted results
• Commodity markets were mixed, with long-side performance delivered by metals such as Silver and Copper, and soft commodities such as Coffee and Orange Juice, and short-side returns in instruments such as Cotton, Lumber and Lean Hogs
• US Dollar strength was a key theme for the quarter, with the US Dollar outperforming against Asian currencies such as the Japanese Yen and Korean Won, and South American currencies such as the Mexican Peso and Brazilian Real
• With significant uncertainty in markets due to ongoing global macroeconomic concerns, the commencement of rate cuts, escalation of tension in the Middle East, and continuing focus on the upcoming US Presidential Election, we can continue to expect volatility, with financial instruments such as equities and bonds at the forefront
• Given the number of "wildcards" on the horizon, in our view, Trend Following, with its in-built risk management framework and inherent diversification of underlying instruments, continues to be an attractive alternative asset class

Featured chart - S&P500

• The S&P500 has continued to perform strongly, and reached all time highs of almost 5,700 in July
• The level of concentration of the index is high, with nearly a third of the index across seven technology sector stocks - and the rate of increase in concentration has been rapid
• With risks to the American economy (hard landing / recession, inflation, unemployment), as well as global macroeconomic and the Presidential election, commentators are questioning whether a correction may be near or even underway
• Trend Following provides exposure to the S&P500 as it trends, but will also exit the trade without emotion as and when the trend reverses