Thu, 13/12/2012 - 12:41
Real estate investors will continue to encounter low interest rates, muted inflation and sluggish growth in most of the world’s major real estate markets for at least the next couple of years, according to a report by LaSalle Investment Management.
A multi-speed economy has seen low interest rates, low inflation and low growth in the developed world (Eurozone, UK, US and Japan) as opposed to higher inflation, high growth/urbanisation and rising interest rates in the developing world (Central and Eastern Europe, Latin America and Asia Pacific (ex-Japan)).
However, LaSalle believes there are more reasons to be optimistic in 2013 with steady improvement in the world’s three largest economies (US, China, and Germany). Highly accommodative monetary policies are bringing relief to capital-intensive industries like real estate. At the same time, the low cost of debt, along with changes in the regulatory treatment of different kinds of debt, introduce new uncertainties into the real estate investment equation.
LaSalle believes the uncertainties will include: distortions between unsecured and secured lending, uneven access to low-cost real estate credit between countries and within countries, exit uncertainty when unprecedented levels of support for credit markets are eventually withdrawn by central banks and timing/sequencing uncertainty, when monetary tightening occurs before a full recovery in the “real economy” has completely taken hold or is delayed.
Jacques Gordon, global strategist at LaSalle, says: “These uncertainties should result in the vast majority of capital markets remaining extremely risk-averse. This situation is exacerbated by the deep pools of capital that are entering the ‘drawdown’ phase of their lifecycle. During this phase, investors will typically migrate from a long-term growth strategy to a more conservative income-generating one. Even if some investors are in the drawdown phase, where income distributions matter more, extreme risk aversion is no longer warranted. In fact, this approach could create its own set of portfolio risks.
“Investors should look beyond the most risk-averse positions that have built up in their portfolios since the global financial crisis. Ironically, these ‘ultra-core’ positions may carry some of the biggest risks to portfolio performance in the years ahead, as the delayed economic recovery eventually takes hold. We continue to believe that the investment principles, which maintain portfolio diversification as well as ensure that risks are rewarded by appropriately higher returns, are the best way for investors to proceed in this challenging environment.”
In Europe, LaSalle thinks that debt restructuring still needs a lot of hard work. This deleveraging process, while painful in the short run, is absolutely critical for healthy economic growth in the years ahead. The region continues to be beset by the largely unresolved sovereign debt crisis and the real estate occupier markets remain vulnerable but with certain markets weathering the uncertainty better than others. Equity investors are as reluctant as ever to venture far from core assets, while debt investors remain constrained.
Outside of Germany, France and the UK, LaSalle believes lot sizes over EUR80m are often un-financeable by traditional means. Even development schemes with substantial prelets in undersupplied markets are being thwarted by the banks. Indeed the possibility of upward pressure on interest rates will impact real estate yields, further dampening the market. If inflation returns as a result of improving economic fundamentals, yields may remain unaffected.
Gordon says: “We expect fierce bidding to persist for scarce prime assets in London, Paris, and the leading German cities; as a result, their expected returns will be squeezed. Most of today’s capital is likely to remain reluctant to move up the risk curve, despite the higher pro forma returns on offer, due to uncertain leasing prospects and fragile income profiles.”
LaSalle cites mezzanine debt, prime assets, near-CBD submarkets and retail as the best opportunities in Europe.
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