The annual IPD conference offered sobering thought for investors with delusions of grandeur about the RE recovery. Richard Lowe reports
Is the nascent recovery in the real estate markets an illusion brought about by government stimulus packages and over-exuberance on the part of the capital markets? Ian Cullen, co-founder and director of Investment Property Databank (IPD), exclaimed back in February that the UK real estate behaved very oddly in the second half of 2009, with capital values rising at an unprecedented rate while rents actually fell. "It is almost as if property investment has become detached from the real economy, and is instead driven exclusively by highly volatile shifts in capital flows," he said at the time.
The issue of whether the recovery was sustainable was still being discussed in May, at IPD's annual European Property Investment Conference in Amsterdam. With a sovereign debt and currency crisis casting a shadow over Europe, event chair Piet Eichholtz, professor of real estate finance at Maastricht University, talked of mirages. "It did appear that the tough times were behind us, but then Greece happened, so the question is now whether there is real recovery or whether what appears as a recovery in some markets is in fact a mirage," he said. "If it exists, how do we profit from it, who will profit from it and by doing what?"
Joe Valente, head of investment strategy at Allianz Real Estate, was one of the first speakers to question the sustainability of the recovery. He said investors had failed to learn the lessons of the financial crisis and were still overestimating opportunity and underestimating risk. "I am not convinced the industry has seen the error of its ways. When people talk about going back to fundamentals, or basics, or core, I don't believe a word of it," he said. "One year ago we were all going to die - 12 months on we are doing sub-4% deals in London and sub-5% deals in suburban Frankfurt. Have we learnt any lessons? No."
Andrew Wood, CIO at MGPA, echoed Valente's sentiments. "I agree with Joe and question what we have learnt and wonder why we are doing some of the things we are doing," he said. "Are we still underestimating risk and over-estimating opportunity? I think there is a real possibility we are."
Sabina Kalyan, head of European strategy at CBRE Investors, cautioned that the debt crisis in Greece and its repercussions across the euro-zone could endanger what was "an incipient rental recovery". The chance of a double-dip recession in Europe has "increased substantially" as a result of the continent entering into "a period of deliberately engineered fiscal deflation", she said.
The importance of learning from previous mistakes was also emphasised by Antonio Alvarez, head of investments at Aberdeen Property Investors. He said this applied to both fund managers and investors. While some funds were definitely mismanaged - "sometimes fund managers were conflicted or not careful about the financial risks in their funds" - investors also failed to grasp the full implications of being exposed to high levels of leverage, he said.
Anne Breen, head of property at Standard Life Investments, moved the topic away from debt management to liquidity management. She said the performance of funds before and during the downturn had been closely linked to cash-flow management.
Breen said: "Large diversified liquid funds have broadly underperformed in this cycle due to the pressures to invest, and need to subsequently sell quickly to meet redemptions. The funds that have outperformed are those that have managed their cash flows most effectively."
If the global real estate market recovery is sustained it will not be synchronised, argued Mark Callender, head of property research at Schroders, defending the role of diversification, which had been questioned by some investors due to the indiscriminate effects of the downturn on all asset classes. He said: "Future returns on an international property portfolio will therefore be less volatile than returns on a purely domestic portfolio. Investors should limit exposure to markets highly integrated with the world economy - such as financial centres, energy and commodities - and set a minimum weighting to sectors relatively insulated from the global economy, such as retail, government-dominated office markets and medical surgeries."
Laurent Lavergne, head of fund management at AXA Real Estate, spoke about new Solvency II regulations, which will come into play for insurance companies by the end of 2012, and what impact this might have on their investment appetite for real estate. It was an unusually technical presentation (in a non-real estate sense) for an IPD event, but the audience and moderator Eichholtz grasped the potential significance of the new rules.
The new regulations, which are subject to ongoing alteration, could make real estate investments more expensive for insurance companies which will have to hold more capital reserves to safeguard against losses resulting from financial market shocks. Insurance companies will need to reserve enough capital to cover a 25% loss in the real estate investments. Of course, riskier investments such as equities (although it should be noted that listed real estate is included here) require even greater levels of capital reserves.
Is this likely to have "a massive shock on the markets" and lead to a "pullback of capital", Eichholtz asked. Lavergne responded that this scenario was not very likely but it was a real risk. Lavergne's main worry was that if markets did drop by 25%, insurance companies would still have to hold enough capital to safeguard against a successive drop of 25%, despite the probability of the event having diminished.
Rupert Nabarro, founding chairman of IPD, closed the conference by praising the quality of debate around how the real estate investment industry had emerged from the crisis."We had 15 years of tremendous, bustling, unprincipled growth which was brought to a halt and we have had to reorganise our markets," he said. He also noted how the nature of the annual conference had reflected the position of power in which investors find themselves today in relation to the fund management industry, and how some of the larger investors from the Middle East and Asia were increasingly participating in the IPD community. "We have got to a position where the investors are in charge. They certainly weren't in the early years," Nabarro said. "We have new investors: there are half a dozen sovereign wealth managers attending this conference, who, along with long-standing investors, are all demanding better reporting."