2011 Investment Strategy Annual released by LaSalle Investment Management
The multi-speed global economic recovery and fast-moving capital markets will create a demanding environment for real estate investors in 2011, according to LaSalle Investment Management (‘LaSalle’), which today released the 17th edition of its Investment Strategy Annual, a comprehensive survey of, and outlook for, the global real estate markets in 2011.
Looking back at 2010, a number of trends were evident. Real estate pricing recovered rapidly for “ultra” core properties, deal flow picked up across the three regions and most importantly real estate fundamentals for investors improved modestly in Europe and North America but impressively in Australia, Hong Kong, Singapore, and China.
But as we look forward to 2011, LaSalle believes that property investors need to get prepared for the challenging realities of a multi-speed global recovery. With continuing aftershocks of the global financial crisis still occurring, very different strategies need to be used depending on which country you are investing in. For example in Asia Pacific, development and leasing will provide some of the best investment opportunities, while edge-of-core properties will be attractive in the UK, France and the United States. Investors should look to take advantage of financial distress in Japan, Mexico, the US, the UK and Germany.
Commenting on the report, Jacques Gordon, Global Strategist at LaSalle Investment Management said:
“Investment performance in the rapidly growing countries will be volatile, due to the waves of liquidity that wash over these less mature markets. Growth strategies that take advantage of rapid urbanization and a burgeoning middle class will be most successful. In the low-growth countries, investment performance will get a boost from low interest rates and a rising flow of debt and equity capital, despite the weak recovery”.
The extreme difficulty of getting macro calls exactly right reminds us of the importance of taking a balanced, disciplined and portfolio-wide approach to property investing.
Report co-author Robin Goodchild, LaSalle Investment Management’s Head of European Research and Strategy continues:
“Portfolio managers should anticipate taking a more aggressive stance toward leasing, re-financing, and selling in 2011. As deal flow picks up, investors will be able to re-position portfolios through more active management for the first time in several years”.
Although each country will offer up a different mix of opportunities, LaSalle believes that investors should consider a number of global themes unfolding in the year ahead:
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Banks will prove to be a greater and greater source of deal flow
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Exit strategies for core real estate will be highly executable
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Investors will have to broaden their targets beyond long-leased prime properties in world-city markets if they are to achieve required returns.
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Mezzanine debt will still be expensive and scarce; yet demand will rise
LaSalle also believes that investors should prepare for another year of surprises. Here are some they are tracking:
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Global Imbalances and Currency Wars
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Government Taxation of Real Estate
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Rise of Chinese Institutional Investors
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Entity-level distress
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Re-starting stalled development
In the report LaSalle highlights structural shifts in play in the world of real estate. One such trend is energy efficiency and sustainability – an issue that has been building for some time but which according to LaSalle’s research is now ignored at investors’ peril.
Bill Maher, Director of North American investment strategy says: “Successful real estate investing today requires anticipation of factors that influence future, not just current, cash flows. Our research shows that investors in Europe place the most importance on this issue when choosing managers. While US pension funds rarely regard the issue as crucial we expect this outlook to change as evidence accumulates”.
Regional Outlook
The multi-speed economic recovery will produce a long, slow return to equilibrium in the Eurozone, Japan, the UK, and the US. Much higher levels of occupier demand will be manifest in the largest developing markets—China, India, and Brazil—as well as in the developed countries that ride closely in their wake (especially Australia, Hong Kong, and Singapore). In the G-7 countries, low interest rates are pushing up real estate pricing for prime, fully-leased properties. Jacques Gordon, Global Strategist at LaSalle Investment Management puts it this way,
“As long as this combination of low rates and wide real estate spreads holds up, investors can take the view that they are being well-compensated for owning a cyclical, (albeit low correlated) asset class.” In the Emerging Markets and in the developed markets of Australia, Hong Kong, and Singapore, investors can earn
strong returns through leasing and development.
Europe
Alistair Seaton, LaSalle Investment Management’s Senior Strategist for Europe, said: “The economic prospects for Europe remain divergent, but it is now clear that the fears over solvency in Greece were overly alarmist. However, fiscal weakness in Greece, Ireland, Portugal, and Spain will continue to fuel concerns over whether the Eurozone can continue it its current form. Despite the original intentions of the single currency, Europe remains a heterogeneous region. This diversity will provide opportunities for investors, but there will be few easy wins given the subdued economic backdrop. The primary challenge will be investing in a low growth environment without taking on unwanted or unmanageable risks.”
Core European investors should focus on assets with secure income for the next few years, as the economy and market conditions will provide little growth. Assets without secure income should be avoided until risks are reflected in pricing, which should start to occur as 2011 unfolds. The best opportunities will be in the three largest markets of the UK, France, and Germany. These countries are also the most mature, transparent, and liquid real estate markets in Europe, creating a good and reliable environment. Poland, with strong economic growth and a large domestic market, looks attractive but we would advise caution in investing in the rest of Central and Eastern Europe. All product types offer value in the different markets, but we would generally overweight to retail for long-term growth and stable income.
In the main markets, we recommend the following investment focus:
United Kingdom: Retail and central London offices. Portfolios should underweight regions outside the South East (particularly offices).
France: Offices, retail, and logistics.
Germany: Retail and logistics.
Investors seeking higher returns should look to banks seeking to reduce their exposure to property. There is an estimated debt funding gap of €115 billion across Europe, so plenty of stock will emerge eventually. The bulk of these assets are in the UK and Spain, followed by Germany and France. Arguably, the most compelling current investment strategy is the provision of mezzanine finance, as there is otherwise little debt available above a 65% loan-to-value ratio. This can offer attractive yields secured against strong underlying real estate.
However, over the next 12 months occupier demand will strengthen so the debt opportunity probably has a finite duration. As occupier markets improve in late 2011, investors should start to move up the risk curve to avoid the crush of capital seeking core assets. Although weak fundamentals continue to make this challenging, the situation is improving in comparison to the previous two years.
North America
William Maher, Head of US Strategy, LaSalle Investment Management said, “With accelerating job growth in 2011 in the US, we should be seeing lower vacancy rates and a stable flow of capital on both the debt and equity sides of the market. While investor appetite for risk starts to grow once again, value-add and opportunistic investing will be more attractive in the States, with core investing showing the most signs for improvement with their attractive yields relative to fixed income. Additionally, with more debt and equity available, we anticipate transaction volume climbing towards a more normal level of $150-200 billion by the end of 2011”.
The most attractive core investment opportunities in North America in 2011 are those that capitalize on economic sectors, such as technology, health care, and entertainment, which will outpace the national average or take advantage of pent-up demand.
In the US, the best higher-return opportunities will finally stem from the recent over-leveraging of real estate, particularly during 2005-2007. Little of the distress to date has resulted in attractive investment opportunities (either debt or assets) but that will change in 2011 as banks and special servicers realize that delays face the risk of slow economic growth and/or higher interest rates.
For office investors in the US, the safest core office opportunities will continue to be the large and liquid markets of New York City, Washington, DC, and Boston, but investors should get higher returns in the best properties in knowledge-driven secondary markets (e.g., Minneapolis, Portland, Denver, Philadelphia, etc.) that investors have shunned for the last several years.
Across North America, the most attractive opportunities for core industrial investments are in national distribution hubs (such as Los Angeles, Toronto, and Chicago). Above average returns are likely in second-tier ports such as Seattle, Houston, and Vancouver. In Mexico, returns for build-to-suit industrial development in central Mexico and Monterrey will be attractive because of the expansion of domestic demand and manufacturing.
Core apartment fundamentals are strong in supply constrained coastal markets, but pricing is very rich and may be unfavorable for low leverage core investors. Still, long term apartment fundamentals are solid and investors should maintain at least a market weight in this property type. Apartments are the only property type where development returns will be attractive in 2011.
Despite a weak consumer-spending outlook, attractive opportunities for retail investment exist in all three nations. In the US and Canada, necessity based retail centers offer stable operations and income due to tenants that are less exposed to weak consumer spending. In Mexico, the growth of the middle class and the lack of modern retail centers make development of build-to-suit grocery centers a good higher return strategy.
Asia-Pacific
Kenneth Tsang, Head of Asia Pacific Strategy, LaSalle Investment Management said, “Opportunities in Asia Pacific will remain broad-based in 2011, both in the indirect and direct markets. A number of IPOs by large regional industrial and Chinese developers will increase the investible space in the listed sector. Real estate debt will offer more opportunities as falling values have generated large gaps in the capital structure in Japan; lack of development finance will create more opportunities for operators with proven track records and strong bank relationships. Value, recovery, and growth markets exist within the region and offer a diverse investment landscape for core and opportunistic capital.”
The best 2011 investment opportunities in the Asia Pacific region are:
Japan: Recommended strategies include buying quality commercial assets at attractive prices and at wider than normal spreads over debt costs, development of modern logistic facilities, and suburban retail as consumers’ preferences shift towards value-for-money retail outlets from traditional retail formats.
Hong Kong and Singapore: Existing office space will benefit from strong cyclical recovery of the office sector as demand is returning while rents are undervalued. Asset repositioning and value added investing in existing office and retail will generate attractive risk-adjusted returns.
Australia and Singapore: Hotels in Australia (supply-constrained cities) and Singapore are attractive as operating performance is firming quickly.
China: The best opportunity is selective residential developments in China’s second-tier cities, focusing on high-quality projects and developers with proven track records. Domestic core investors in China should consider selective quality office and retail assets in first-tier and advanced second-tier cities, as long-term demand is strong while liquidity is surging.
Japan and Australia: Rescue capital or bridge financing in Japan and Australia as capital gaps will continue to emerge in the CMBS markets and banks’ portfolios.
