As global real estate strategies have developed in recent years, global gateway cities have inevitably grabbed much of investors’ attention. There are now good reasons why international investors should pick from a much wider menu of city options when building their global real estate portfolios.
The growing body of evidence of investment performance points to the value of adding regional gateway cities, and other nationally significant markets to global gateways, into the strategic mix. Looking at MSCI data for the last 10 years, global gateways tend to show higher growth but lower income yields than other cities, meaning there are many smaller cities with higher overall performance. This then doesn’t usually come at the cost of greater total return volatility. But what about income risk and durability? Taking the example of London, there is little evidence that lease lengths and tenant quality are better in the capital city than elsewhere in the UK.
So how can investors choose the cities that will meet their strategic needs? TH Real Estate research has identified 188 “investible” cities, of which 91 are positively influenced by global “megatrends” that can provide insights into their long-term prospects. Even though global investors often start by looking at the largest and best-known city markets, this may be not the best approach, as they often don’t offer as much diversification potential as smaller cities. Cities with stronger “soft” factors like quality of life may also have more sustainable performance prospects. At the same time, many of those cities with the strongest growth prospects are now up-and-coming locations in emerging Asian markets.
The choice for investors is not simply which cities to pick, but also where in those cities – which are often large conurbations – to buy an asset. We’re increasingly seeing that investors say that cities and districts within cities – rather than countries or regions – are the most important geographic dimensions when making real estate investment decisions. We need to consider what we really mean by a city. Cities spread much further than the bounds of administrative borders or the tight definitions of a Central Business District. You may even conclude that most relevant definition could extend to an hour-long commute from the centre. Investors with access to tools that allow them to analyse cities in this more flexible way, may be able to unearth hidden pockets of value, whilst still accessing the attractive performance potential usually associated with the CBD.
It is, however, possible to overplay the importance of the city in the context of national political and economic dynamics. Even global gateway cities have high correlations with their national markets, indicating they are exposed to common risk factors, but they do still seem to outperform their national market peers. A good example of this is in Italy, where Bologna and Milan had been able to buck the national market trend, or even London which boasts real estate opportunities more desirable to many investors than perhaps any other global city.
Will Robson, executive director and global head of Real Estate Applied Research, MSCI