Much of what is currently happening in the capital markets is no longer explicable solely in terms of a market efficiency thesis, as Thomas Beyerle reports
Property has definitively matured and has become an autonomous asset class and a vital constituent of many investment portfolios. However, we now see that because of the sub-prime crisis, a fully fledged asset category - transparent, with high transaction speeds and volumes, and benefiting from continuous valuation - has to bow to the rules of the capital market.
What this means in a context of tumbling share prices and a crisis of confidence on the credit side is not difficult to visualise. The current phenomenon is this: the ‘forces' at present driving the property markets are increasingly originating in the financial markets, and are subject to extreme mood swings. But despite the loan crisis, international capital is still looking for attractive investment options, and will be considering real estate as not the least of them.
When we look at the target allocation quotas for this asset category among institutional investors, we see an enormous amount of pent-up demand, which is being met increasingly through scalable, internationally diversified indirect property investment products. Thanks to more sophisticated analysis and the greater variety of asset classes, many institutional investors have decided to invest more in real estate over the coming years; most will allocate more to property over the next 24 months.
The reasons they give for this are: growth opportunities, cash flow orientation and risk hedging. We presume that the rise in property allocations will be triggered not only by the market impact of declining stock valuations but also by additional investments in direct and - more likely - indirect real estate.
In terms of real estate economics, 2007 ended with very good results, though the mood on the capital markets was nervous as the new year dawned. One upbeat message is clear straightaway: the fundamentals of the property market continue to be very good.
The capital markets are still volatile but this has nothing to do with the actual economy or the underlying fundamentals of the capital market products. It signifies that the capital market players are re-evaluating their risks, ie, they are currently upgrading their perceived importance.
But is this a property crisis? Certainly not. However, the mood has changed in the property market as well. Portfolio transactions are being delayed, opportunists are disappearing and rumours are increasingly influencing the capital and property markets. The purchase prices for portfolios are falling, "core investors with well-filled wallets" are being eagerly courted.
But it would be a mistake to conclude that a downward spiral could be triggered in 2008 because of the market mood and an absence of clear signals from the market. The lack of debt capital for opportunistic investors and leveraged buyers is one thing. The rising strategic demand for real estate among many institutional investors is another.
This trend could be accentuated by the fact that high volatility in capital markets always provokes a rush into more stable asset classes, traditionally bonds. Even though the market outlook for bonds has brightened, investor confidence has declined since structured products appeared in so-called money market portfolios, which caused their value to tumble inside a few days due to their poor quality and transparency. This should encourage sensible capital flows into real estate.
Analyse the substance, apply rational thinking and don't make any decisions without thinking them through carefully - this is the message from the property market analysts, who in recent years have laboriously paved the way for a research-based investment approach. The actual substance of the property markets is better than ever: turnover, lettings and rentals are rising. Trend for 2008: continue to buy!
But we have to accept that these data alone can no longer entirely explain market behaviour. Correlation is not the same as causality. In phases of market uncertainty, decision makers look for blueprints - but these do not yet exist in the altered market mechanisms of this asset category. Welcome to the financial markets.
What can now explain developments on the market are the tools of behavioural psychology and economics, ie, we need to address the rationality involved in investment decisions. The associated academic discipline is called ‘behavioural finance', where investment processes are examined on the basis of information processing and decision-forming. This is the only way to render transparent and comprehensible the apparently illogical or irrational behaviour of investors and the concomitant developments in the market.
The sector has barely begun to get to grips with the behaviour-oriented approach - this is a task for the academics. Decision makers, though, need to know right now what they should do in the current market. Much of what is currently happening in the capital markets is no longer explicable solely in terms of a market efficiency thesis. The property sector will inevitably have to deal with the uncertainties and volatility in the capital markets if they are not to succumb to them.
Accordingly, property investors should, in the months ahead, listen more than ever to their common sense, pursue their chosen strategies, remain disciplined, and make rational use of their experience. This usually teaches us that the values and parameters applying to the property market are still different from those found in the capital markets. After all, investment is not the same as speculation. And in volatile times particularly, there are investment opportunities in abundance, so players in the property market should be looking for investment opportunities now.
Optimal allocations to real estate cannot be achieved over the short or medium term. The real demand and the hunger for real estate, nevertheless, should be able to be met for the time being, assuming that the underlying asset, the property, is subject to an appraisal in line with the market.
Thomas Beyerle is head of research and strategy at DEGI
