Real estate survey 2006: A perfect storm

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By:
Louise Bowman
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It offers double-digit yields, is not correlated with the equity market and provides secure, long-term returns. Allocations of investment capital to real estate have therefore ballooned – and look set to keep on growing. Louise Bowman reports.

Real estate awards 2006: 
                                          
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Find out which banks, law firms, property companies and advisors lead the way in global real estate in Euromoney’s second annual ranking. With investors pouring into the sector, market leadership can be highly profitable. Research by Kalin Trifonov.

WHAT’S NOT TO like about real estate as an asset class? This is a question that many investors are struggling to answer. Everyone from private investors, property funds, the institutional sector, commercial and investment banks and traditional property companies just can’t get enough bricks and mortar into their portfolios. “Volumes of capital investment in real estate are at record highs globally and at half-year are tracking ahead of 2005 levels,” says Mike Strong, chairman at CB Richard Ellis, which tops the global advisory category in Euromoney’s real estate poll this year.

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Strong points to the widespread re-evaluation of property as an asset class as the cause of this unprecedented strength of demand. Broadly based low inflation, together with interest rates being at low long-term levels, have created a “perfect storm” for the asset class. “Investors have increased their weighting in real estate over the last five years following a long perod of underinvestment during the 20-year period prior to that,” he says, adding that this increase in weighting still has a long way to run. “Investors have rediscovered the value of secure, long-term income returns, coupled with capital growth,” he says.

According to DTZ research, the total value of invested real estate stock is $7.9 trillion. Of this total the US accounted for 41% ($3.3 trillion), Europe and the UK 38% ($3 trillion) and Asia 20.4% ($1.6 trillion). But how might those figures look in 10 years’ time? The capital requirements of the high-growth emerging economies of India and China mean that their share of this total will inevitably grow. According to Lisi Qiu at DTZ Research, if Asia Pacific real estate stock maintains its current rate of growth it will exceed European stock in three years’ time and US stock in five years’ time.

The US real estate market was dominated by public to private activity last year, with deals such as Blackstone Group’s $5.6 billion acquisition of Carr America Realty and $8.9 billion acquisition (with Brookfield Properties Group) of Trizec Properties examples of the trend. “There are extraordinary levels of private equity capital looking to invest in real estate,” says Devin Murphy, global head of real estate investment banking at Deutsche Bank in New York. Deutsche Bank was runner-up to winner Eurohypo in the global commercial banking category this year.

US direct and indirect real estate returns
As of September 30, 2005; values rebased to 100
Source: NAREIT, NCREIF, Property & Portfolio Research

In Europe, direct investment volumes in real estate have jumped 30% year on year in the first half of 2006 and, according to Jones Lang LaSalle, are expected to hit €180 billion to €200 billion in the second half of the year. JLL topped the property management category in this year’s poll. Rapid change in Germany’s real estate market should mean that its share of the investable universe grows significantly, and France has increased its share of investment activity to 15% – thanks partly to the successful implementation of SIIC legislation. According to the JLL research, Germany accounted for 25% of all cross-border investment activity in Europe in the first half of 2006, pushing it ahead of France and only marginally behind the UK in this regard.


Another notable event in Europe is the re-emergence of the public capital markets as a way in which to finance real estate. In Germany there have been massive privatizations of distressed debt and real estate – and the next step in this process could be IPOs of this exposure. Indeed, Fortress Group recently announced plans to undertake an IPO of €1 billion of the portfolio it acquired from Gagfah in Germany in what could be the largest real estate IPO to date in Europe and the first significant such deal since Canary Wharf in the late 1990s.

European direct and indirect real estate returns
As of September 30, 2005; values rebased to 100
Source: Global Property Research, Investment propert Databank

There is certainly strong appetite for such trades, and more of the opportunity funds that have taken large exposure to German real estate might follow suit. “Returns from real estate have consistently exceeded all other asset classes over each of the past three-, five- and 10-year periods,” says Strong at CBRE. “Investors buy property for a combination of income and capital growth,” he says. “Much of the return from real estate over the past three years has been delivered by a reduction in yields. However, we are now seeing rental growth in the major central business districts and a widespread fall in vacancy rates. Therefore income returns are forecast to grow over the next three years, a good fundamental reason to invest in real estate with a low inflation and low interest rate environment.”


The volumes of investment allocated to real estate will continue to grow until there are clear signs of weakening performance. And this is a very long tailed asset class in which changes take a considerable amount of time to show through. There certainly will not be any change in 2007, as allocation decisions have already been made and large amounts of allocated money have yet to be invested.

“The demands of India and China will definitely take money away from the traditional real estate markets,” says Jon Vaccaro, global head of commercial real estate at Deutsche Bank. “This will not be a problem for the traditional markets in the short term but it might be in the long term. Returns in India are in the high teens on an unlevered basis – that is three times what can be achieved in the US and Europe.”

The market has certainly undergone astonishing internationalization over the past two to three years and property funds now allocate investment globally as a matter of course. Large volumes of European and US real estate have been funded by petrodollars from the Middle East and Russia. US and European investors have piled into Asian property funds. But while there are clearly significant volumes of new capital being allocated to real estate, there is also a wall of demand coming from the infrastructure requirements of the emerging economies. To what extent this will result in a sizeable redirection of capital flows remains to be seen.

But amid the euphoria there are voices calling for caution. In his foreword to the recent de Montford University analysis of commercial real estate lending in the UK, Alistair Ross Goobey, director of commercial office and mixed use developer Argent Group, warns: “The rise in investment values, coming almost exclusively from compression of investment yields, has only just kept pace with the increase in lending to the sector, and it is impossible to unravel which is cause and which is effect. Lenders seem still to be easing their criteria and are even lending on speculative developments. We have been here before,” he warns. “Although there is no imminent danger in much of this lending, we may face purgatory postponed, as the debt comes to be rolled over in a less benign environment.”

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