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Brighter prospects for 2025, though uncertainties abound

Policy rate cuts across markets are well underway, with key central banks performing multiple cuts in the second half of 2024. Towards the end of 2024, inflation increased in many countries, but remained below 3%. We expect interest rates to continue on a downward trajectory, though with significant differences between the US, where we expect fewer further cuts, and Europe, where the economy is weaker. Moreover, we expect interest rates to stabilize above pre-pandemic levels, and we do not expect a return to the wide spread between real estate yields and borrowing costs which prevailed for much of the post-global financial crisis decade.

Global real estate investment activity in 4Q24 resumed its gradual recovery, according to preliminary figures from MSCI adjusted for seasonal effects. For 4Q24, preliminary data from NCREIF showed a 0.1% QoQ capital return for US Open End Diversified Core Equity (ODCE) funds and MSCI/AREF reported a 1.8% QoQ capital return for the UK All Balanced Open-Ended Property Fund Index. Capital values appear to have stabilized, with moderate growth expected in 2025. When navigating the rebound potential of the real estate market, it’s important to give careful consideration to capital allocation as rising tides may not lift all boats.

The tariffs proposed by the Trump administration will likely impact trade volumes, be it as an actual pullback or just slower growth, and could pose a risk to occupier demand for logistics properties globally. Logistics facilities around transport nodes look most exposed – airports, ports and land borders. Overall, we think caution is warranted on international logistics property moving into 2025.

Clean energy and AI uncertainties testing investors’ mettle

In our 2025 Infrastructure Outlook, we were optimistic about the macro for infrastructure, as various indicators and market factors aligned favorably. However, we cautioned investors against herd mentality, especially around megatrends like decarbonization and digitalization. This past week brought some uncertainties to these themes.

On decarbonization, President Trump issued numerous executive orders targeting clean energy. While most of these are expected, the order that issued a temporary pause in onshore wind permitting surprised markets, and may delay some projects in the near term. We previously warned that markets are underestimating potential policy headwinds, and the debate around the Inflation Reduction Act repeal is yet to begin. Nonetheless, policy changes are not new to the sector, and savvy investors can mitigate these risks through favorable contracts, legal mechanisms, and deal structures.

On digitalization, the recent success of DeepSeek’s AI model challenges the bullish outlook for data centers and electricity demand. As previously argued, digital infrastructure is a technology-agnostic way to gain exposure to technology megatrends, as it provides the backbone to these innovations without direct technology risks. If more efficient AI models emerge, we’ll likely see new market entrants, thus sustaining industry growth. This is an example of Jevon’s Paradox (as pointed out by Microsoft CEO Satya Nadella), where something that is more resource efficient simply increases demand for that resource (e.g., more efficient cars increases the distance people drive and gasoline demand).

Overall, we’re still strong believers of the infrastructure megatrends, although recent headlines only reaffirm our view that investors need to avoid herd mentality, understand their own competitive advantages, and remain disciplined to succeed.

Differentiation to drive returns

Investors continue to express positive sentiment on private equity as measured by intent to maintain or increase allocations. This comes in spite of a 2024 which delivered modest results to LPs; funds overall showed positive quarterly returns for the first time since 2021, and exit activity has resumed slower than expected.

The macro backdrop is mostly positive: growing 2024 M&A volume is expected to continue in 2025, which should translate to increased exit activity and distributions to investors. Consensus is for interest rates to continue falling, reducing cost of borrowing and thereby increasing levered private equity returns; some new deals are already seen to factor in an expectation for cheaper and more available debt. And in the US, the largest private equity market, the new administration is seen as positive for risk assets.

Today’s best-positioned managers have a) a strong fundamental value creation strategy, rooted in increasing top- and bottom-line company performance; b) discipline in entry multiple and investment pacing; and c) a good up-market reputation boosting exit demand.

Fundraising remains challenging, with persistently lower distributions in recent years weighing on allocations. Still, rebalancing following advancing public markets is expected to boost private equity allocations heading into 2025. Large managers are out-raising smaller and emerging managers by increasingly wide margins in a trend which shows little sign of abating. The fundraising environment is another factor contributing to an active secondary market with favorable dynamics for patient capital, both in GP-led deals and quality LP stakes.

Residential credit amid rising mortgage rates

Following a downward trend in mortgage rates in the US during the third quarter of 2024, mortgage rates began rising again during the fourth quarter – increasing from 6.08% on 30 September 2024 to 6.85% on 31 December 2024. Overall, this move impacts the US housing market and the various asset classes related to housing. US housing fundamentals generally remain strong as home prices have been relatively resilient despite the increase in mortgage rates and stretched affordability metrics. The strength has been primarily driven by limited supply, low locked-in rates, and low loan-to-value (LTVs) on most existing mortgages.

Housing supply remains constrained due to the lock-in effect of mortgage rates, which has allowed existing homeowners to weather the increase in interest rates because mortgages which originated prior to the mid-2022 rate rise are at fixed rates and several hundred basis points below the prevailing market rates today. In addition, prior years of home price appreciation has resulted in a substantial decline in LTVs for most borrowers.

There are multiple ways for credit strategies to capitalize on this market dynamic. In tradable markets, agency mortgage derivatives continue to have a strong fundamental profile. The strategy directly benefits from rising mortgage rates and most assets have generated consistent cash flow as a result of slow prepayment speeds. In addition, project finance strategies that fund the development of single-family housing communities in the US also remains a compelling opportunity. These deals have capitalized on the limited supply of existing housing stock and US homebuilders have demonstrated the ability to solve prospective buyers’ affordability challenges through rate buydowns.