Comment: Universalizing location
It is one of the giant global industries, right up there with food and healthcare; it provides the collateral for a high proportion of loans in the world banking system and for growing volumes of securities, but it remains obstinately driven by local factors of supply and demand.
Real estate presents a conundrum. For the world’s largest investors it has many of the characteristics of an institutional global asset class to which they should consider allocating a portion of their funds to achieve diversification relative to bonds and equities, a hedge against inflation and potentially attractive returns.
Securitization of real estate equity as well as debt has made this easier than ever to implement. As Reits spread around the world, global investors will be able to buy and sell exposure to different geographies and classes of real estate much more easily and at lower transaction costs than through buying actual buildings themselves. They can already take positions in bonds secured against cashflows from loans to different classes of real estate in different geographies.
No wonder then that large US pension funds and similar institutional investors are now debating not whether to invest but what proportion of their funds to dedicate to the asset class: should it be as much as 10%, or even more?
Yet real estate is far from being a consolidated global industry. There are no property companies to compare with the handful of global leaders in the auto, chemicals or pharmaceuticals industries. And there are limits to how end investors and specialist asset managers can deploy common metrics to compare valuations and risks in different markets. Commercial real estate may be performing as well in Perth as in New York but the key dynamics driving just supply – planning processes, land availability, replacement cost – will be unique to each. And how can anyone compare these drivers with those pushing up the value of multi-family residences in China, industrial parks in Mumbai and retail developments in Warsaw.
In the US, the recent trend has been for larger, more diversified Reits to be taken private, broken up and the pieces sold down to local specialists. So when Blackstone bought EOP, the country’s largest Reit, it sold large blocks off immediately to local specialists. Did it overpay for EOP’s New York offices, or has it got a great price now that it’s sold them on? Ask real estate experts in the US and they’ll tell you the same thing: they don’t know – but they reckon that no one knows the New York office market better than Macklowe Properties, which acquired the New York portfolio from Blackstone. They defer to the local experts.
However, even though real estate is the ultimate local market play, one or two investors have constructed global real estate portfolios, meeting great success and extraordinary growth rates. GE invests for its own account. It used simply to finance real estate until it saw the huge returns its customers were achieving and decided to buy for its own balance sheet. Today the company’s real estate portfolio is worth $71 billion (up from $21 billion in 2000) and GE now derives 9% of its total earnings from real estate.
Morgan Stanley set up a $400 million fund to acquire distressed real estate assets in North America in 1991. Today that has grown into a $73 billion assets under management business. Sources say that the investment bank now makes more money from real estate than it does from equity capital markets and its real estate managers have now been asked to lead forward the entire asset management side of the business.
That kind of growth brings its own challenges, which we will explore in future issues, but will undoubtedly inspire imitators.
So while commentators worry about toppy real estate markets – in Spanish residential or US sub-prime – it’s worth bearing in mind that we’re not at the end of the global real estate investment cycle: we’re at the very beginning.