LaSalle IM expects more froth in global real estate markets

Real estate assets are starting to look pricey in some cities across the globe, but there are very few red lights, according to Jeff Jacobson, global CEO at LaSalle Investment Management.

‘The lights are yellow in some markets, but they haven't turned red,’ he said in an interview with PropertyEU. ‘We’re not (quite) at the point of excess, there is more froth to come. I think we’re at the mid to late stage of the cycle.’

In that context, the UK is out of sync with the eurozone, added Simon Marrison, CEO of La Salle Investment Management Europe. ‘The UK economy is vibrant, it’s one market in Europe where you can credibly underwrite rental growth. It’s not just about London, it’s also about emerging locations and regional cities like Manchester and Birmingham.’

Marrison conceded that real estate yields in the UK are near to record levels, but pointed out that they are underpinned by rental growth. ‘When QE tails away, we would expect to see some softening of yields, but it will be cushioned by rental growth.’

Rise in interest rates
In Europe by contrast, QE has only just started to kick in, Marrison pointed out. ‘GDP has been upwardly revised this year in France, recovery is slowly starting, but it’s fragile. I can’t see interest rates being raised (any time) soon. And when they do start to rise, the UK will be first. As long as the eurozone is not as far down the road to recovery, the impact on that front will be limited.’

Compared to other asset classes such as government bonds and equities, real estate continues to tick the boxes, Jacobson continued. ‘Real estate returns still look relatively attractive, particularly for the income component and the lower volatility. There’s nothing in the short term that’s going to change that.’

For the foreseeable future, global capital flows driven by unprecedented Central Bank monetary policies, will continue to target the sector, he added. ‘There has never been such a synchronised tidal wave of monetary accommodation in human history, and a meaningful amount of that is moving into commercial real estate.’

Markets that are seeing some froth, Jacobson said, include residential in Central London and certain cities in the US such as San Francisco and Houston, Texas where zoning regulations are less restrictive and barriers to development are lower. But on the whole, the fundamentals remain favourable, he maintained.

‘The banking system is healthier than it was pre-crisis, it’s not like 2007. There are very few places in the world where there’s true distress. The economic recovery may be much slower than we’ve seen historically. But in the larger cities, we’re seeing record capital values and rents are picking up strongly in the best markets like the US, UK and Germany.’

Demand is improving slowly in most areas, he added. ‘Some countries are lagging and economic growth is flat in some places, but we’re seeing generally stable to slowly growing market recovery.’

Quantitative easing
A key factor driving the sustained popularity of real estate globally is the record low level of interest rates on the back of an extended period of quantitative easing, Jacobson said.

‘Monetary policy will normalize at some point, but the moment when it will happen keeps getting put back. For the moment, we’re still seeing more capital and greater risk appetite. There is going to be a change at some point and when that happens, the question is: what does that mean for real estate? A rapid rise in interest rates, which we do not foresee in the short to medium term, will clearly have a negative impact on real estate values, but it will also have an impact on all other asset classes as well.’

A differentiating factor of the current cycle is that there is very little new supply, Jacobson said. In 2011, financing dried up almost completely, stifling new developments, he added. ‘If you look at previous cycles and how we screwed up in our own industry, there was invariably an increase in development and a dramatic increase in gearing. The story is better there now on both fronts. In Paris, there is almost nothing being developed, and new stock in Germany is also fairly limited. Development pipelines are clearly picking up in markets like London and parts of the US, but overall they remain fairly restrained for now.’

Capital values have clearly moved above long-term trend lines in most markets which increases the probability that investment returns going forward may disappoint expectations, Jacobson noted. 'As in any cyclical market, there will be a mean reversion to trend at some point. This can either happen through an abrupt correction or a "plateauing" where capital values remain flat for a period of time.

‘The further you move away from the mean, the less comfortable investors should get as the risk of a more severe correction goes up. But it feels good at the moment… if you look at development and gearing levels, investors have been exercising caution so far…I see yellow lights but don’t yet see any red lights on those fronts.’