Re-pricing of real estate is well underway but there are important differences between regions and across property types, according to LaSalle Investment Management (“LaSalle”), which today released the 15th edition of its Investment Strategy Annual, a comprehensive survey of, and outlook for, the global real estate markets for 2009.
The report notes that commercial real estate was not a precipitating cause of the Global Financial Crisis, but it is now caught up in a vicious cycle of value destruction, along with virtually every other asset class. Securitized real estate – both debt and equity – has already gone through several rounds of violent and volatile re-pricing. Private equity real estate will also. In this environment, LaSalle advises, the first objective for investors must be to protect income streams and secondly to look beyond current market conditions in order to take advantage of capital shortages and re-pricing.
In terms of a more defensive approach, LaSalle recommends ‘back to basics’ portfolio management, which means managing liquidity well and staying close to tenants, working with them on early renewals and adjusting rents quickly to meet new market realities. It also suggests an emphasis on markets and sectors that are recession-resistant. These include healthcare, federal or national government capitals and necessity (as opposed to discretionary) retail.
LaSalle suggests that the third great wave of opportunistic investing will start to take shape in the midst of the Global Financial Crisis and a global recession. The report advises investors to set aside time in 2009 to watch the opportunistic sectors carefully and to evaluate offerings as they come into view. In terms of attractive sectors, it recommends:
§ REIT shares trading at a massive discount
§ Fund units trading at steep discounts
§ Non-performing loans or pools of partially performing loans
§ Defaulted land deals or development deals in need of recapitalisation, but priced such that investors get incomplete improvements at close to zero cost
Looking at attractive geographies, the report notes that the UK is leading the way in terms of re-pricing while for structural reasons the US market has been slower to re-price its real estate assets. Australia, Korea and Germany are other countries where re-pricing is well underway while Canada and the eastern cities of China lag behind with the US.
Commenting on the report, Jacques Gordon, Global Strategist at LaSalle Investment Management said: “Markets experiencing a generational correction offer as many opportunities as threats. For investors with capital and the confidence to look through the downturn, 2009 will provide some fantastic opportunities; the strategic approach is to distinguish between the assets that are genuinely attractively priced and those that should be even cheaper.”
Report co-author Robin Goodchild, LaSalle Investment Management’s Head of European Research and Strategy, continues: “We continue to believe that a disciplined investment process and an explicit strategy are the best ways to approach large, complex and chaotic markets. This is especially true during periods of great volatility. Playing a strong defense will be critical to emerging from this period as a winner”
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 2009.
According to LaSalle, real estate markets across Europe (excluding the UK) will see lower investment returns in 2009, but that it will be a rare opportunity to acquire high quality assets at attractive prices. “North America will have a difficult year as fundamentals weaken significantly with the region far behind the UK in terms of re-pricing”, says Bill Maher, North American Strategist. For Asia Pacific, which was previously resilient, the outlook for 2009 has worsened but is expected to outperform Europe and North America.
Europe – opportunities and risks: Occupier sentiment is weakening and what started as a pricing correction is being compounded by concerns over rental growth prospects. For cash rich investors not dependent on bank financing, opportunities will start arising in 2009 through acquisitions from forced sellers.
§ Countries most at risk from the slowdown are Spain, the UK and the Netherlands where both commercial and residential property are over-heated.
§ Office take-up will be lower as corporate expansion and relocation decisions are put on hold while office tenants become increasingly reluctant to pay high prime rents. Many projects will be put on hold with the London, Madrid and Frankfurt markets most at risk.
§ Occupier demand for prime shopping centres remains high across most of Europe but has weakened in Sweden and France. Secondary shopping centres have seen a more widespread fall in demand. The best opportunities are likely to be in Poland and Turkey.
§ Although still concentrated in the UK, France and Germany, the European logistics market is expanding geographically into Central and Eastern Europe (CEE). Developers will focus on pre-letting space before starting construction.
§ Investors should start to tilt their portfolios from offices towards retail as it proves a more defensive stock with restrictions on demand making it more recession proof.
§ Best target markets are France, Germany, Scandinavia and the UK, depending on pricing.
§ On a range of measures UK real estate pricing offers one of the best acquisition opportunities since the early 1990s with the earliest opportunities in the prime market which has higher levels of liquidity and prices have corrected ahead of poorer quality stock.
§ Main emphasis over the next 12-24 months should be on acquiring well-located core assets that should return 8% to 12% (unleveraged). Those wanting higher risk investments should seek distressed assets (both equity and debt) which may deliver 15%+, dependent on the availability of leverage.
North America – leading edge of the storm: Weak economic performance, troubled capital markets and deteriorating property markets mean that 2009 will be a down year for North American real estate investments. Although Canada and Mexico will outperform markets in the United States, returns in all these countries will decline. The low point in the cycle is expected in 2010 but there will be buying opportunities in the next one to two years.
§ Reverberations of the credit crisis will be felt strongly in 2009 and beyond, particularly in the US. Both debt and equity will be difficult to attain which will in turn generate lower transaction volume.
§ Key facts shaping the market will be: a shortage of debt financing; a lack of core capital; leveraged equity out of market due to debt terms; rising property market distress and capital market distress.
§ US office will be very weak due to 23% of tenants linked to the financial services industry and the warehouse market is expected to weaken. There will be further weaknesses in the retail property sector with rising vacancy rates.
§ Canada has entered the slowdown in relatively good economic health, with vacancy rates at historic lows, and with much of its core property market dominated by patient, disciplined institutional ownership. Thus re-pricing in Canada is not expected to be as severe as many other nations. Re-pricing will be more acute in secondary markets and among non-core property types. Selected acquisition opportunities at attractive prices are expected to emerge in late 2009.
§ Mexico City, the country’s largest office market is relatively well positioned to face lower economic growth in 2009-2010 driven by a diversified service sector. Industrial border markets will be most affected by the US slowdown – particularly automotive. Demand for housing and retail will slow in 2009.
§ Overall, expensive and hard to obtain financing will contribute to a general lack of liquidity, particularly in the US. Real estate transaction markets should start to open up in 2009/early 2010 as more sellers face financial distress.
§ Investors should place greater emphasis on defensive property types such as multi-family, necessity retail with long leases and non-cyclical sectors such as healthcare and education.
§ The most interesting investment opportunities in 2009 will emanate from distressed owners, borrowers and lenders.
Asia-Pacific – credit confidence crisis: Outlook for the region significantly deteriorated in 2008 as the capital crisis reached Asia Pacific. David Edwards, Asia Pacific Strategist, comments: “Although growth in the region is likely to exceed other major regions, the slower prospects for the US and Europe will continue to degrade prospects for 2009-2010. Japan will struggle with a weak export environment, India will be adversely affected by slower investment in IT and China will be affected as export demand weakens.”
§ Short leases that prevail in the region’s real estate markets will result in a large number of rent reviews which will translate into corrections in capital values. The lack of liquidity in the debt markets will exacerbate the short-term impact on these real estate markets.
§ However, real estate fundamentals remain in relatively good shape and there will be investment opportunities in 2009 and beyond.
§ Offices in Tokyo will experience sustained occupational demand as large-scale redundancies are unlikely. In Hong Kong there will be corrections in what is a volatile CBD market. In China expansion will be curtailed until the global economy improves and high levels of supply will create higher than expected vacancies.
§ In Japan, the retail sector has only recently been recognised as an asset class and signs of weakness caused a knee-jerk reaction in the capital markets. However, re-pricing may present interesting acquisition opportunities. Retail in Australia remains solid and there is likely to be some downward correction in Hong Kong and Singapore. China and India continue to benefit from strong growth prospects of household incomes and resultant consumer spending.
§ Industrial markets in Japan should continue to witness a sustained period of stable demand from occupiers. In Hong Kong supply of warehousing is constrained; in India it remains challenged by local infrastructure deficiencies while in Singapore demand for modern facilities will continue to grow. There will be medium term opportunities in Australia and in China the industrial sector is still at an embryonic stage.
§ Demand for hotels will continue to go through a sectoral shift as Chinese, Indian and Russian travellers become more important source markets. A severe short-term correction will present an excellent opportunity to gain access to a sector that has bright prospects long term.
§ LaSalle does not expect market-wide distress in the Asia-Pacific region but there will be entity-level distress due to unsustainable debt burdens. Some of the best opportunities may already be emerging.
§ The credit crisis is causing a re-pricing in the capital markets, both for equity and debt. Opportunities are expected to arise first in the more mature markets where banks are more diligent and will push owners into making uncomfortable decisions. The initial focus for core investors should be Australia and Japan.
