Despite the increasing transfer of new products to the market, further structural and cultural change is required. Joe Valente reports
One of the most exciting developments in during this cycle has been the way the real estate industry has become more effective in placing capital.
Over the past five to 10 years the size and nature of the real estate investment universe has expanded. In terms of geography, investors have been willing to consider investment opportunities in emerging markets. The CEE was regarded as emerging 10 years ago but that quickly gave way to India and China with Russia, Latin America and Vietnam also attracting considerable attention more recently.
During the same period we have seen an explosion of different investment vehicles and ways of accessing the market. The number of listed and unlisted vehicles has blossomed while the development of public markets (equity and debt) greatly improved not just transparency but general liquidity as well.
The definition of investment-grade stock has also been revolutionised in terms of the property sector. Historically, institutional investment came down to an allocation of capital between offices, retail, industrial and possibly a tiny percentage of specialist classes (housing, hotels etc). The exact make-up differed globally: in the Netherlands housing was always seen as institutional while in the US and Australia, for example, the rise in REITS/LPTs prompted the emergence of asset-backed businesses (hotels, self-storage facilities, infrastructure) as institutional asset classes.
The industry has come a long way in improving the efficiency in deploying capital in the real estate market. However, given the fact that an estimated $2.4trn (€1.8trn) is still looking to be invested in real estate, and that estimates suggest that up to 50% of capital raised over the last two years remains unspent, it is clear that the industry still has a considerable way to go in teasing new product to the investment market. While development activity has been rising recently, it has not provided a sufficient source of investment product over the course of this cycle. The most important source of new product has been the transfer of assets from corporate balance sheets, as well as from local and central government. It is likely that this will continue to be a major trend in coming years.
Globally, it is estimated that total stock of real estate comprises $25trn of which $9.5trn is currently in the investment market, an implied owner-occupied ratio of 62%.
However, this rate of owner occupation varies not only across region but over time as well. The overwhelming trend is for companies to rent rather than own, the rationale being that the corporates should deploy capital in developing its core business rather than concentrating on being a major owner of real estate. This process is most developed in the US where the level of owner-occupation has fallen to around 40%. Moreover, the trend towards renting rather than owning means that, globally, around 1% of assets held by corporates on their balance sheet are transferred into the investment market each year.
The US led this process over the last 20 years. As a result the level of owner-occupation in most other mature economies tends to be substantially higher. In Europe there are distinct tiers:
Exactly the same tier structure is evident in the Asia Pacific region with the lowest level of owner-occupation found in the more developed economies such as Singapore, Hong Kong and Japan. While the overall trend is towards the renting of real estate, the process is clearly at different stages in different countries for a variety of reasons. These may include legislation, ownership structure of major enterprises (Germany, Korea), as well as cultural reasons.
In Europe the transfer of real estate assets to the investment market is currently running at around $15bn per year, which is roughly equivalent to 15% of total investment activity. It is therefore already an important source of investment grade stock for real estate investors. This proportion has been rising over the last five to six years and is likely to increase as a result of a number of factors:
The level of outsourcing of real estate assets over the next three to five years is likely to be around $40-50bn judging by the continued interest of governments in this area, as well as the continuing transfer of assets from corporates. The emergence and development of REIT-type vehicles, particularly in the UK and Germany, may well speed this process up.
Perhaps the most significant trigger for the transfer of assets into the investment market is pain. Either poor profitability, share underperformance relative to competitors or indeed public sector debt. This has been an important driver historically but, arguably, it has also been the source of weakness. By definition it promotes a reactive view of real estate held by corporates and governments since the release of value on the balance sheet is determined by internal considerations rather than the most opportune time to transfer those assets into the property investment market. The view of corporate/public sector real estate as a positive source of value is probably one of the biggest changes likely in the short to medium term.
Joe Valente is head of research at DTZ Consulting and Research