Real estate: A false sense of security

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Investors can’t get enough of real estate. But property developers should get ready for the wall of money to shift to emerging markets.

The amount of money in property is staggering: the total invested stock of real estate worldwide is $7.98 trillion. But despite the sector’s size, the total investment allocated to it exceeds the amount it can digest by some margin. Investors simply can’t get enough of this asset class.

The reason for this happy situation is straightforward: real estate has outperformed just about every other asset class by any measure in recent years and has acted as an attractive alternative for institutional money looking to move out of equities. Products such as Reits and CMBS have oiled the wheels of investment and there is now massive, internationalized issuance of capital.

Property companies in the US and Europe have, as a consequence, enjoyed a very nice run and their fundraising costs have fallen through the floor. And even with the expected weakening in economic performance, particularly in the US, few expect this to change. Or will it?

In the short term, property companies and developers can relax, as the wall of money falling at their feet is not going anywhere. But these companies should be thinking to the long term. The ballooning demand for real estate investment from high-growth economies such as India and China means that investment will inevitably be redirected away from traditional markets – and at astonishing speed.

If invested real estate stock in Asia Pacific keeps growing at its current annual rate of 15%, it will surpass Europe in just two years and, remarkably, will be larger than the US in a mere five years. That kind of growth requires massive investment and should be ringing alarm bells in the traditional real estate markets.

Asia Pacific currently makes up just 22% of global real estate but that will not be the case for long. Merrill Lynch has forecast that the Indian real estate sector will grow from $12 billion in 2005 to $90 billion by 2015. It is no surprise that the world’s largest Reit is in Hong Kong (Link Reit) and the Chinese government has been forced to introduce measures to dampen down rampant overseas speculation in real estate.

The Middle East and Russia – long sources of real estate investment elsewhere – are also turning from exporters of real estate capital to importers. Developments such as the Palm Islands resorts in Dubai give an indication of the size of future demand from the region.

Indirect vehicles dominate real estate purchases (in Europe, for example, they account for two-thirds of all purchases) and as Reits and property funds become more global it will become easier for all investors to increase their allocations to high-growth markets. But direct investment is also burgeoning: an estimated $5 billion of private equity money is now chasing Indian property.

But it is most important that the property companies themselves increase their levels of direct investment in high-growth real estate markets. This is in order to best position themselves for the day when the wall of money from these regions that has been long been flowing in their direction turns into a wall of demand.

Markets will never be the same again.

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