Simon Fairchild, managing director at IPD North America

US real estate emerges from two and a half year slump, IPD says

The range of returns to investors in US core open-ended funds remain above long-term norms, despite the recovery in market values over the second quarter, IPD research has shown.

Underlying US commercial real estate markets have emerged from two and a half years of write-downs with a quarterly positive capital return of 2.2 per cent – contributing to a 4.0 per cent total return, as measured by the IPD US Quarterly Property Index.

However, coming out of the real estate recession there have been a number of mixed signals.

“Some funds are experiencing substantial inflows of new money while the aggregate position points to overall redemptions,” says Simon Fairchild, managing director at IPD North America.

“At this stage in the cycle we would expect to see investors coming back in to buy assets at the re-priced levels, which have now fallen by more than a third, but the overall net disinvestment reveals an inconsistent pattern of fund activity.

“This seems to be because the capital flowing back into US real estate is risk-averse and chasing prime stock that owners do not want to sell. Perversely, at the prime end, the environment is operating as a sellers’ market with prime stock-owners demanding premiums to consider transactions. All of this confirms that the pick up in the market is far from uniform.”

Income returns, which helped deliver the first quarterly positive total return in two years last quarter, nudged upwards by ten basis points over three months to June. The two components of performance combined to deliver a quarterly total of 4.0 per cent. The annual capital growth rate is now -6.7 per cent but a strong income return of 7.1 per cent has pulled the return for the 12 months to June to -0.1 per cent.

At the gross fund return level (taking into account other assets, cash and liabilities) funds are returning to positive territory with the exception of those with high leveraged positions.

The return to capital growth among US core open-ended real estate funds over the second quarter masks a divergence in fund returns driven by leverage, according to IPD.

There was a 2.2 per cent spread in quarterly, unleveraged performance from best to worst, counting from fifth to 95th fund percentile to strip-out performance outliers, over the three months to June 2010.

But an analysis of the headline figure reveals the spread of fund returns when including all assets and debt – which among the open-ended funds in the IPD US Databank was an average of 30.7 per cent – jumps to 3.8 per cent between the top five per cent and bottom five per cent.

Overall, although there is an uptick in transaction activity, net investment is still negative. And the pace of disinvestment among the funds has decreased by more than a third quarter-on-quarter (37.5 per cent) to -USD347m over the second quarter, an improvement on the -USD612m in the first quarter.

After the onset of the credit crunch in the summer of 2007, US values continued to rise modestly to the end of the year, by 3.3 per cent, before the subsequent sudden collapse in values which saw prices decline by more than a third (-33.6 per cent) over Q1 2008 to Q1 2010.

Five years of price appreciation to the end of 2007, which saw values rise by 39.1 per cent, was eroded in less than two years, bottoming out at levels below all the gains made throughout the noughties.

“The return to capital appreciation could be a brief one, with the economic picture worsening again,” warns Fairchild. “If this does prove to be a brief respite before further unwinding, investors will need to be prepared for setbacks with increased volatility in the performance of their investments.”

The IPD US Quarterly Property Index measures USD77.3bn worth of properties in predominantly core open-ended funds.

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