ULI TRENDS: Property experts see extended period of market recalibration

A large number of statistics for European real estate are remarkably, possibly even ‘alarmingly’, similar to the situation in 2006, delegates at the ULI Trends Conference in London heard on Tuesday.

‘Investment volumes are up, yields are down and we’re seeing a big increase in M&A activity,’ Jos Short, chairman of Internos Global Investors, said during a capital markets session entitled: ‘Tipping points – What will trigger, where and when?’

After presenting the audience with a barrage of statistics, Short went on to ask the panel in his role as moderator: how long will the current cycle last? In his own answer, Short pointed to a recent comment made by former Land Securities executive Mike Hussey. Currently CEO of Almacantar, Hussey is widely recognised as a bellwether of the London property market.

‘Mike Hussey,’ Short said before handing the floor to his panellists, ‘says there’s another 10 years for central London development.’

The view from Helen Gordon, global head of real estate asset management at RBS, was somewhat less bullish. ‘I think the development cycle will slow down quite significantly,’ she said, but added that the cycle still had ‘at least another 12 months’.

Meanwhile, UK investment volumes may be up 25% on volumes last year but they will slow down by the end of the year, she predicted. ‘For the UK market, the spectre of a referendum (about membership of the EU, ed.) and a potential Brexit could have a dampening effect further down the road,’ she added.

Capital markets versus real economy
Graham Barnes, executive director at advisory firm CBRE, argued that capital markets have so far led the current cycle while the underlying fundamentals still have to catch up. ‘We’ve had a lot of the capital cycle, but the real economy is showing the behaviours of the early cycle,’ he said. ‘The services sector cycle, for example, is still at a very early stage of recovery...looking at a three-year horizon, one of our researchers said recently that he had never seen a better set of graphs.’

Many of the statistics Short revealed for 2014 may be broadly similar to those for 2006, but there are a number of key differences, Ellen Brunsberg, CEO of GE Capital Real Estate, said. For example, the 5-year swap rate stood at 5.5% in 2006, while in 2014 it was just 1.9%. The shape and quantity of quantitative easing are unprecedented and real estate values do not reflect where interest rates are, the panellists agreed.

‘I think we’re on a long track here, trying to figure out what normal rates and returns are,’ she said, pointing to the historically low bond yields and interest rates. ‘We haven’t seen a world like this. I think we will continue to see some recalibrating…and it won’t be like a clock, I think it will be linear and it will go on. So I guess I’m bullish in a weird way.’

Turning to the topic of debt, Gordon of RBS said her bank was open for business. ‘We’re lending, also on developments in a limited way, albeit not on the same LTVs (as pre-crisis, ed.) Different lenders with different appetites are also getting into it,’ she said, but added that LTV levels remain ‘cautious’.

CBRE’s Barnes pointed out that a large proportion of new lending involves refinancing and that volumes are currently more like the levels seen between 2002-03. ‘Do I think banks will shoot themselves at some point in the future? Yes, I think they will. But if you ask me whether we are near that point, I would say we’re nowhere near that point yet.’

Listen to the music
At the same time, he conceded, a certain recklessness is becoming visible in the market. Pointing to a recent discussion he had with a fund manager, Barnes said some investors are telling their managers to ‘just deploy the money’. ‘This is a concern,’ he added. ‘The fund manager I spoke to said to me: “I feel like I’m spending the money, not investing it.” We’re starting to hear that sort of music a bit more.’

Another characteristic peculiar to the current cycle is the speed of market recovery, Gordon said. Initially the UK and Irish markets were both very closed, but after measures were taken to stimulate them, they both opened up very quickly and that velocity has become a trend across other markets, she said. ‘Each market that has opened up has gone faster and faster. Even the poor stuff is going faster as well.’

The panel also signalled that volatility is increasing in both bond and equities markets. Macro players like hedge funds move in and out of REITs, Brunsberg noted. 'They get out if they don’t like the smell, or if they like oil or gas better. Looking at it from a capital markets point of view rather than from a bricks and mortar view, the metrics are different.'

Both velocity and volatility could change the market and in that sense there are parallels with the previous crisis, she added.

‘It was debt that fuelled the crisis, but the tipping point was the velocity of trading. Debt was the vehicle for that. So when we see how fast prices are rising, you need to understand what is causing that and why investors are paying higher prices. When money is going into property or any other asset class and investors don’t know why they’re buying it, there will be some dumb investments. Fortunately though there are also some very good investors.‘

Black swans and other unknown knowns and unknowns
Asked to comment on potential 'black swan' events, the panel threw up a variety of possibilities including the threat of a Brexit and the rise of far-left political groups across Europe like the Syriza party in Greece and Podaeos in Spain. 'Political moves to the left could completely change what is happening,' noted Short.

On the real estate front, the industry is still coming to terms with the fallout from the Lehman crisis and the shattered confidence in structured products and greater regulation, the conference heard. In due course, regulators could also start looking at private equity markets, GE's Brunsberg said. 'That could be a huge disruptor if that happens.'

For the time being, however, real estate continues to benefit from being the 'least worst place' to invest, the panel agreed. Moderator Jos Short summed it up neatly: 'Real estate is the tallest dwarf in the room,' he said in his concluding remarks.