Rupert Nabarro founded IPD in 1985 with a staff of three, which has now grown to nearly 250. His achievement in bringing more clarity to an asset class lacking transparency have been recognised. He is an honorary fellow of the RICS, a life fellow of the Society of Property Researchers and was awarded an OBE in 2006. He talks to Martin Hurst about the current market situation, the provision of data at such turbulent times and the challenges the company faces as it rolls out its product worldwide
What is your view of developments in the real estate industry over the last five to 10 years?
The industry is completely different to how it was 15 years ago - it is different in organisation and in particular in scale. The amount of commercial real estate held as an investment in the UK by professional investors is five or six times what it was in the mid-1980s. This is clearly out of all proportion with the increase in stock, which might have been 1.5-2% per annum over that period.
There has been a gigantic shift of real estate ownership from traditional corporate owners - retailers insurance companies, banks, government departments - into investor hands. Most of the new real estate that has been built over the last 15 years has been built for investors. This is more marked in the UK than in other markets, but the same has taken place throughout the western world.
There has been enormous internationalisation of real estate markets. For example, when I first tried to set up the IPD business in France 15 years ago there were no foreign owners operating in the Paris market at all; it was all owned by a very narrow group of insurance companies, many of which were publicly owned.
Now with the market very open to international capital there are investors from all over the world buying commercial and residential property in central Paris. This is going on in all the European markets; there has been a major entry of capital into Sweden in the past few years - nobody would have touched it five or ten years ago. Furthermore the major groups are also operating in Italy and have made a very significant impact there, particularly in the shopping centre market.
The big fund managers who operate in equities ignored real estate until very recently - if the investment banks had a real estate arm it was really just to service their own clients; they wouldn't have thought of it as a profit centre in its own right.
Over a very short period we have seen the emergence of very large specialist property fund management groups that are attached to fund managers in other asset classes and that have applied their techniques to the real estate asset class. They can see that there is a bigger market and there are much more fees to be earned and that the growth will continue.
The owners of property - pension funds, insurance companies and the like - have mostly moved their properties out to professional fund managers.
What has led to the current crisis?
The first major difference between this and previous booms is that this one has been investor led. One of the first things to happen was the application of debt vehicles to property investment. At the height of the 1980s' boom there was approximately £30bn (€42bn) of outstanding debt in the property market and it is now about five times that.
Today virtually every real estate transaction has debt applied to it - that is new. This has inflated enormously the amount of money available to buy real estate and as a result prices were bid up to quite artificial levels, as a result of which some people have got very burnt fingers.
Too much money has pushed up prices too far, external circumstances have changed, and people do not see value at current price levels. It is proving very difficult for commentators to say how great the fall will be - they haven't got the models and they don't know what the reaction of other new sources of capital to lower prices will be.
We were clear that the market was pretty high and we have been saying this with increasing insistence over the past 18 months. To say what the level of fallout will be is almost impossible, although the measure I take of the fall is linked to the increase that has taken place. The monthly index has shown a fall in yields every month from the end of 1994 to this summer with the exception of four months when the dot.com boom collapsed. A market that is being driven by a falling yield almost continuously for 13 years is almost unbelievable. Investors believed that property with the same cash flow would continue to increase in value.
In the present situation, where virtually everyone would say that fair value is below current value, I don't think we will see a great deal of activity.
The other thing that is different this time is that in Europe and North America there has not been the enormous flow of development that one would have expected given that the fall in yields should have encouraged developers to jump in. As ever the estimates of the development pipeline are not very good.
We hope that the strength of the economy will be sufficient to absorb the development when it comes, but if the economy were to weaken significantly - and you just have to look around the City of London to see how many sites under construction there are - and if that started to be the cause of pressure and adverse comments people would become much more concerned about the commercial market than they are at present.
What are your views on US sub-prime crisis and the prospects of a US recession?
It is natural, but new, to try to meet investor appetite for risk by splitting debt into opportunistic, value-add, core plus etc, concepts which were unknown in the UK five years ago, and where the definitions have not yet been fully agreed. This meant applying more debt to certain types of investment than others. Central to the current issue is the fact that much lending has gone on to risks that have not been properly calculated.
While I saw this happening I hadn't realised the implication of loan packages that were being securitised. I am self-critical about our inability to build this into our models and realise what the risks involved are. Banks have been lending billions - are the people making the loans really as experienced as they should be?
What can the industry learn?
Clearly we must learn that debt is a very important part of the model to predict property markets. The really difficult question now is whether the elements of the sub-prime crisis exist for the loans that have been extended and securitised in the UK and the rest of Europe. If this is the case quite a lot of that stock is going to be infected and the potential for losses will escalate.
It is quite clear that the traditional lending ratios in the UK and elsewhere have been disregarded by the banks in recent years. A banker commented recently that there has been no demand for mezzanine debt in the last three to four years because the level of loan to value lending has been such that nobody has needed to take mezzanine debt. This implies that much higher levels of debt have been applied to many of the properties than would have been expected.
As a result of this, higher interest margins are being applied to lending around the world, which then impacts on the prices people are willing to pay for properties.
What is the relationship between higher margins on bank lending and the shift in the actual yield applied to property? We will start tracking that relationship but an answer is not possible at present.
What are the challenges facing you as a data provider at times of turbulence?
Indices are based on appraisal data to establish capital value. But in valuing any asset you need to know the income and the yield. One half of the equation - income and potential income - is more certain than it is for equities. Anything to do with the income is known - events that might affect it such as the precise impact of the risk of any tenant not paying his rent, for example. There is excellent data on this. So in one respect property valuation is an easier job than corporate valuations for a stock market price.
On the other hand you don't have all the prices available on a fixed exchange; you must rely on the estimates of the professional valuers. The profession of capital valuations is in much better shape than it was 10 years ago - there are far fewer firms doing it with far better information tools and much better financial models. Also the markets are much more open, much more property is being traded and much more information being made available for this purpose. So in principle real estate valuation is easier than it was in the past.
However, in practice it is unbelievably difficult at a time like the present when the market completely seizes up. We don't know what average risk premium the average investor wants to apply to a relatively certain income. The reason people don't want to act is because they don't trust the valuation figures. Our data is great when lots of transaction evidence is coming through but if there are not many then you have to take a weather eye and look more at the broad macroeconomic situation.
Valuers are being lent on by people who don't want values pulled back too far but there are others who do want them pulled back quickly and a long way, because the quicker the correction takes place the quicker the market will get going again.
There is a lot of posturing about wanting to get back into the market, but my guess is that it will be difficult to make a case to buy property for some time into the future. Very few people will have enough money to make a big transaction at present.
The last 10 years have been fantastic for IPD - we have gone from five to 22 countries, and collect much more data. But the boom of the last three or so years hasn't been easy. This is firstly because there are a lot of very opportunistic investors in the market. The long-standing real estate investors want to share their data in order to produce market and portfolio information.
But many of the opportunistic investors have been exactly the opposite, wanting to obscure their returns behind really complicated financial structures, saying that IPD information would be irrelevant to them. So although the size of our samples has increased everywhere, in some areas we have not been picking up as much of the new investment as we would like among the very opportunistic funds. I hope that in the years ahead we will return to more traditional investment channels and that more data will come into IPD.
What challenges do you face in individual countries and regions as you roll out and develop your product?
In difficult periods people want data more than they do in boom periods because of the uncertainty. We have a clear mantra which is that we want to produce data more frequently, more quickly and with larger and more accurate samples. It is very good in the main western countries of Scandinavia, the Netherlands, France, the UK, and it is pretty good in Australasia and North America.
The roll-out of our index in Asia is slow because many of the emerging economies are still completely dominated by new development, which doesn't lend itself to appraisals of cash flows and valuations. People always want information about the next market they want to go into without realising that we can only measure the market once they have been in it! So there is a constant tension there. But it does play itself out over time - we have just published our first set of results for eastern Europe, for example.
We always have to be sure with marginal countries whether we have a big enough sample to start publishing data. China, Malaysia, Thailand, South America - we have to wait until there is a sufficiently large market for property investments so that services including data provision can happen.
We are producing an international service in as many countries as we can. If we are to do this we have to respect local conventions. Regarding German valuations - there is a very big investment property market in Germany and there are professional funds which are owned by retail investors. Furthermore the German government is aware of the need to keep orderly markets. Some of the comments about German valuations are based on limited understanding of the local circumstances. The German valuations system has elements which are not acceptable in the UK like the fact that private individuals perform valuations, rather than professional companies, or the very close relationship that exists between valuers and some funds.
These factors are not very desirable. But I would suspect that the German valuation system is much better than many of its US and UK critics give it credit for - there are serious valuers valuing properties for serious funds.
We have always said that the sample we are measuring in Germany comprises German open-ended funds, big insurance companies, a few pension funds and international investors. We follow German valuation conventions and describe these. The results have been better than people make out. There have been issues such as the criticism of the figures we produced in April this year showing very slight year-on-year change in valuations.
Following this criticism we made a proposal for a major study to be conducted by a panel of academics to see what they could find out about the accuracy of the IPD information in the various jurisdictions. We wanted to pay the academics for this very large research study and sought financing from the main stakeholders. We took our proposal to the German investment houses, ministry of finance, and the equivalent of the RICS in Germany. They said no, fearing that it would involve more criticism of German valuation methods. We then took it to big international investors.
International investors said no, it's up to the valuers. Then we had a meeting with the main five international valuers in London who also said no. Everyone just said they didn't see any major value in this project. I only take from this story that the critics of the German system are not as concerned privately as they are publicly.