Investment Strategy Annual 2010 released by LaSalle Investment Management

Across the globe, 2010 is likely to be reasonably good for real estate investment across most markets, according to LaSalle Investment Management (‘LaSalle’), which today released the 16^th edition of its Investment Strategy Annual, a comprehensive survey of, and outlook for, the global real estate markets in 2010.

LaSalle’s report notes that the free-fall in values has stopped in nearly all the major markets it follows and the early stages of restored investor confidence have begun.  The market is already seeing improved visibility on pricing and rising transaction volumes.  In 2010, LaSalle expects to see a further re-alignment in the pricing of risk with deal flow increasing modestly as sellers gradually come out of denial. Investors should seek an appropriate balance between: 1) total risk aversion, which is already leading to a surplus of capital targeting a handful of ultra-safe deals and 2) inappropriate risk tolerance in a period of economic uncertainty.

Commenting on the report, Jacques Gordon, Global Strategist at LaSalle Investment Management said:

“Overall, investors in commercial real estate should be cautiously optimistic about the outlook in 2010.  However, as a late cycle participant in the general economic recovery, real estate will behave differently from other asset classes.  The income streams from leased buildings weathered the global recession in remarkably good shape, but as leases mature in generally weak markets, net operating income will be under downward pressure in many countries for several years to come.  

“At the same time, in terms of stimulus packages and bail outs, commercial property has been treated quite differently from residential real estate, banking and other industry sectors.  And private equity prices have not yet recovered as robustly as stocks or bonds.  All these differences mean that real estate’s diversifying power in a portfolio will be restored.”

LaSalle acknowledges that investors have good reason to be risk averse but suggests that in 2010 (and even more so in 2011) they can look forward to more rational pricing and, in cases of distressed properties and owners, some very compelling opportunities. As they develop investment strategies for 2010-2011, investors with a clear view of the returns they require can prosper, says LaSalle.

In terms of the major risks to commercial property, the report’s authors believe this lies with the capital markets, which are expected to be the main driver of performance, while economies are weak. Yet, real estate capital markets could be quite volatile in the years ahead, says LaSalle.  It warns that the unintended consequences of monetary and fiscal stimulus policies of many governments could lead to too much money flowing back into property ahead of a solid recovery in fundamentals. This excess liquidity risk is already building in China and, to a lesser extent, the UK. To ameliorate this risk, investors should maintain a strict discipline that focuses on achieving a required return with realistic underwriting.

Looking at the major commercial real estate markets of the world, the report’s authors observe that while they may have fallen together during the peak of the credit crisis, they are recovering in very different and surprising ways.

In the UK for example, LaSalle notes the sharp rebound in prices and says that, while capital values will still increase, it is now clear that the best opportunities in the UK have passed.  In Continental Europe the investment environment continues to vary considerably: France and Germany are set to see most of the investment activity in 2010 while re-pricing in other countries continues at varying speeds and Central Eastern Europe continues to be paralyzed.

LaSalle sees a slower recovery in the US as, unlike the UK, the market has still to find a floor with weak economic fundamentals expected to push vacancies up and prices down until the second half of 2010.  Asia is expected to offer investors the greatest range of opportunities in 2010, as China and India grow rapidly and economies that have experienced a contraction in economic output reclaim lost ground by 2010. 

Regional Outlook

Drawing on a global network of research professionals and fund managers, LaSalle’s Investment Strategy Annual provides an in-depth examination of the fundamentals that will shape the real estate markets in Asia-Pacific, Europe and North America in 2010.

Europe – travelling at different speeds

Report co-author Robin Goodchild, LaSalle Investment Management’s Head of European Research and Strategy, continues: “Given a slow economic recovery, investment opportunities in Europe will be driven mainly by capital market movements, as opposed to upward shifts in demand. Liquidity and transparency varies across the continent and both of these factors will impact opportunities and risk.”

Some of the continent-wide themes that will drive opportunities include:

·          Fundamentally Good Real Estate: We favour prime assets likely to have an income stream that can withstand rental decline over the next few years, as well as opportunities that can be positioned to capture rental growth as the occupier markets recover.

·          Partnerships with Financial Institutions: For investors who are prepared to take on asset management-intensive distressed loan portfolios, there should be opportunities as financial institutions offload bad debt from balance sheets.

·          Larger Lot Size: Investors with available equity not dependant on debt finance should take advantage of attractive pricing for larger lot sizes (+ 50 million) for good quality real estate.

·          Sustainable Assets: We believe that demand for sustainable product will continue, driven by green corporate policies, as well as regulatory requirements across Europe.

·          In the UK, with the banks some of the most heavily exposed to the real estate sector within Europe, partnerships with financial institutions could well be the major opportunity.

·          In Continental Europe we continue to favour core retail and warehouses, particularly in France, Germany and Scandinavia.

·          Spain and the CEE will provide some attractive investment opportunities but not until later in 2010 or possibly 2011.

North America – slowly turning the corner

William Maher, Head of US Strategy, LaSalle Investment Management said, “Investment opportunities in North America will improve but are likely to remain limited in 2010, particularly in the United States and in Mexico. In the US, the best opportunities, both core and higher return, will evolve from the resolution of the large level of maturing and failing loans. Investment opportunities in Canada and Mexico are different, with Canada closer to equilibrium in both capital markets and fundamentals, while Mexico will struggle to dig out of a deep recession that is tied to continued consumer weakness in the US.”

·          In the US, we recommend that investors focus on low-risk re-priced core properties. We expect to see a wide range of opportunities to emerge from the problems caused by the excessive leveraging of the real estate sector over the past five years.

·          For core investors, we recommend an overweight position in apartments, which will see demand recover most quickly, and selective investments in retail (e.g. grocery-anchored centres) and modern warehouses in top distribution markets.

·          While market fundamentals argue against office investments, some of the most excessively leveraged deals took place in this sector, so both core and higher-return opportunities may come from highly distressed office owners.

·          Recommended higher return investment strategies include distressed debt (both public and private) as well as a wide range of structures that provide “rescue capital” to private real estate funds, developers, individual assets, and lenders.

·          The over-arching theme for the US will be that new equity capital will command high priority in the return of capital and a preferred return.  Underwriting needs to take into account several years of weak leasing markets.

·          In Mexico low price visibility is expected to continue. Under this environment, we favour for-sale housing (in non-manufacturing markets), which will continue to offer good risk-adjusted returns and high price visibility.

·          Core investors in Canada should overweight apartments, which continue to be the most stable asset type in Canada. We also recommend a market or neutral exposure to the office sector.

Asia-Pacific – taking the lead

Kenneth Tsang, Head of Asia Pacific Strategy, LaSalle Investment Management said, “With a combination of distressed owners and lenders and more rapid economic growth than in other parts of the world, Asia Pacific will provide investors with a wide range of opportunities in 2010.  Core investors should focus on stable markets and sectors, particularly where yields are above long-term levels.  Attractive current returns should be enhanced when capital markets recover and yields fall to normal levels.  Opportunistic investors can take advantage of off-market deals where “rescue capital” is needed to recapitalize a financially-troubled project or to finance a cash-strapped developer.”

·          In the major office markets of Asia Pacific, prime CBD office properties will have the greatest upside as economies and property fundamentals improve.

·          The retail sector has a bright future throughout most of Asia Pacific, both for core investors and for higher return development opportunities. China and many other countries will see both rapid growth and a shift to consumer spending over the next decade and more.

·          Core Retail and Industrial in Japan are attractive. Both the core retail and industrial sectors in Japan are in the early stages of modernization. Newer product will outperform as obsolete space is slowly removed from inventory. We favour suburban retail over urban locations.

·          The Industrial Sector China, Hong Kong and Singapore should out-perform as global trade recovers, while China will see additional benefits from logistic value chain modernization.

·          The core office and warehouse sectors in Australia should perform well, particularly CBD office properties in Sydney and Melbourne.

·          Distressed situations in Japan, including bankrupt developments (particularly industrial and hotels), distressed debt and new warehouse development look particularly attractive.

·          In China, the best higher return opportunities include the residential, retail, and warehouse developments in second tier cities.  Investors should be wary of competing in an overly-frothy market for properties in Beijing and Shanghai.

·          Distressed Debt and Mezzanine Loans in Australia: Higher return opportunities in Australia include distressed debt and mezzanine loans, and warehouse development in hub markets.

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