In a previous chart of the month, we highlighted the negative correlation between of price-to-earnings (P/E) ratio of property and the corresponding five-year forward return. We concluded that lower P/E ratios represented an undervaluation of property and investors should achieve stronger returns. However, when investors see property as undervalued this attracts capital to the sector, increasing its value but reducing expected returns, consequently.

Figure 1 shows the P/E ratio relationship over time and reveals its helpfulness when examining previous cycles. Firstly, after the 2008 Global Financial Crisis (GFC) property values fell sharply, and this is reflected in the lower P/E ratio which was followed by all-property returns in 2010-‘14, twice that of returns in the 2004-‘06 period. We see the same impact on the P/E ratio from 2022 (green line vs orange line) onwards when the rise in interest rates to combat inflation led to falling real estate values and resulting reduction in the P/E ratio.

According to the most recent data and our forecasts, our all-property P/E ratio now indicates that real estate is more accurately priced and moving towards being undervalued. As such, based on our forecasts, this investment vintage represents the strongest prospective 5-year net forward returns since 2017 (8.5%).

Note: All property yield and subsequent P/E ratio and net total returns are formulated as investment volume weighted average of Office, Logistics and Retail.