LaSalle’s mid-year update highlights opportunities and risks from robust recovery of capital markets despite weak fundamentals
Real estate capital markets have raced ahead and ignored distinctions between the fundamentals at work across low-growth and high-growth countries, according to a mid-year update to its Investment Strategy Annual (ISA) report, issued today by LaSalle Investment Management (‘LaSalle’).
Given the nervousness and volatility in other asset classes – most notably European sovereign bonds, Asian stocks, commodity prices and US Treasuries – the relative lack of caution in the real estate capital markets is LaSalle’s biggest worry at the half way stage in 2011. This has shown itself through intense bidding for core assets in several major markets and through the robust capital raising activities of listed real estate companies.
LaSalle does see justification for the perception among lenders and investors that real estate income streams are now at, or just past, trough levels and are once again climbing, even in the low-growth countries. In growth markets, real estate rents and cash flows have been moving upwards rapidly for 12 to 24 months, depending on the specific property type and market. In both cases, LaSalle believes that the capital markets are pricing several strong years of continued growth in the future.
Commenting on the mid-year ISA update, Jacques Gordon, Global Strategist at LaSalle Investment Management said: “The relative lack of caution in the real estate capital markets is a concern. It is remarkable how quickly capital has returned to real estate. The re-emergence of a competitive credit market, so quickly after the bursting of the credit bubble, is also astonishing. Although investing in a capital-rich environment is challenging, opportunities for harvesting gains and recapitalizing assets are now much more executable. Also, capital is moving much more slowly in the near-core, value-add and financially-distressed sectors; we still see good value there.”
“The global economic recovery remains intact, despite several unexpected shocks in the first half of the year. For commercial real estate, the greatest positive feature of recent capital market volatility is that interest rates are very low and are likely to continue to remain so in all the G-7 countries. The biggest risk to real estate performance lies in timing: interest rates could move upward well ahead of any major improvements in fundamentals. Real estate yields would then have to rise to maintain the traditional risk premium for real estate, relative to government bonds. And yet landlords might not yet have the power to raise rents, especially if they have locked-in long-term leases at historically depressed rental rates. “
“Before the world begins to shift inevitably toward a rising interest rate and higher inflation environment, an investment mantra might be summarised this way: borrow long, lease short and index anything that isn’t tied down.”
Regional highlights
Asia Pacific
· Japan’s economy has been hit the hardest of the 30 countries LaSalle follows. However the reconstruction effort is expected to produce a fairly sharp recovery over the next two quarters. Tenants in the logistics and office sectors are seeking modern quarters in regions with reliable power supplies with a renewed sense of purpose. Their readiness to make major relocation decisions benefits modern stock at the expense of older properties.
· China’s economy shows only slight signs of slowing. In the short run, overheated eastern property markets are at risk of policy changes to reduce or eliminate speculative activity. Central markets and secondary coastal market continue to look attractive.
· The Australian economy is thriving, thanks to strong commodity exports. The Sydney and Melbourne residential markets are also attractive, especially for urban infill development projects in well-located neighbourhoods. High housing costs, relatively little new construction and a scarcity of risk capital willing to fund new development make this an interesting sector.
Europe
· Germany, France, the UK and the Nordic countries offer the best insulation from the financial turmoil in peripheral Europe. Poland is also a rising economy, whose property market is maturing rapidly.
· Germany continues to provide the intriguing combination of domestic capital largely side-lined (due to regulatory changes) yet reasonably strong underlying property markets, thanks to industrial/export strength.
· France shares some of these same traits, but the major Parisian markets are attracting a lot of international capital. Retail and logistics may offer better relative value. Manufacturing core properties through leasing, refurbishment and highly selective development opportunities also makes sense.
· The UK offers very specific nodes of opportunity through property tied to infrastructure improvements (Crossrail), shortages of office space in some Central London sub-markets, and a general play toward “manufacturing core”.
· Resolving issues in partially-leased assets or assets needing refurbishment is especially attractive across Western Europe, given the relative strength of capital market demand for fully-let attractive properties.
North America
· Despite the May-June slowdown in job growth, US real estate fundamentals are still gaining momentum, after a devastating two-year stall. The apartment sector is particularly strong, although coastal office markets and the hotel sector are both showing signs of rapid improvement.
· Former high-growth markets (outside the energy belt) that relied on internal growth and immigration remain stalled (Phoenix, Las Vegas, Central Florida).
· The Canadian economy escaped a severe recession and so did its major property types. The energy-driven markets of Calgary and Edmonton took a sharp hit in 2008-2009, and are now recovering rapidly.
· The Mexican economy has picked up its pace of growth considerably in the last six months. Manufacturing and the Tourism sectors are both rebounding, despite continued security issues in the border markets.
