Prospects are still pleasing
If there’s one asset class that has returned to take the headlines in the last three turbulent years it has been real estate. According to Kiran Patel, global head of research and strategy at AXA Real Estate Investment Managers, property has been perceived as the saving grace among investments: “This is partly because it has done well through the attraction of a relatively high yield with low volatility and diversification.”
But while he points out that real estate market fundamentals are not so strong today, he says there is still a lot of appetite from investors.
“Most of this is coming from the German open-ended funds – mostly retail investors who can leverage up their investments. Institutions by and large have slowly increased their real estate exposure by default, but some have done ALM studies and decided that the world is now different and are marginally increasing real estate exposure. On top of that, those who didn’t have any property before are now moving in. So what you have is an environment where prices aren’t falling dramatically because of this increasing appetite.”
Guy Morrell, chief investment officer for global property at Henderson Global Investors, sees a lot of this demand being invested on a pan-European basis: “This is not coming so much from UK investors, but certainly from those in continental Europe and there is quite a lot of evidence to show that cross-border flows of real estate capital in Europe have increased quite dramatically,” he says.
“There is lot of talk at the moment about the German open-ended funds and the returns that are presently available from their core markets such as offices in Germany where returns have been pretty low. Legislation has recently changed to enable them to invest some of their money outside Germany and there is evidence to suggest that that is finding its way both to other parts of continental Europe and further afield too.”
In terms of areas in Europe where Henderson sees real estate opportunities, Morrell firstly reaffirms that core ‘office’ markets, particularly in key markets such as Germany, are unlikely to see attractive returns. However, he adds that more provincial types of retail markets are more attractive.
“Although there’s still demand for prime offices in continental Europe, we don’t generally favour this sector at present.
“Retail warehousing has been performing strongly in the UK recently and we also see value in many retail markets in continental Europe and our joint venture with Pradera, which invests in out-of-town retailing in continental Europe has been going well.”
Patel at Axa agrees that Germany is a poor market at present across most sectors, through a combination of low yields, a hurting economy and a surplus of development. Another market, he notes, that underestimated the economic slow down is The Netherlands, where Amsterdam is experiencing the worst real estate slow down since the last cycle and vacancy rates have gone up to about 12%.
Cities that have held up better, but look set to feel some pain going forward, he opines, include London, Brussels and Rome, although the latter two, he comments, may be buffered somewhat by strong public sector oriented property demand.
For Central & Eastern Europe (CEE), Morrell at Henderson feels it may be a little early to talk of real investment prospects, noting that current market conditions are prompting a safety-first approach from investors: “A while ago there was quite a lot of talk about opportunistic funds in CEE, but I think the mood has changed quite considerably and investors are focused on core and value-added type returns and low risk particularly.
“In this environment some parts of Eastern Europe are probably not top of the list because investors are hungry for stable returns and lower risks. My reading of the current situation is that there has been a concentration across the core markets.”
On a more general note, both agree that office space has been the worse hit of the real estate sectors.
Retail has fared better, but as Patel notes access is not easy: “What you find is that you can only get small holdings because most is held by the large supermarkets and shopping centre players. Everyone wants retail but can’t get hold of it.”
“Another sector that has done well across Europe is residential because of the low cost of borrowing. However, Europe is facing rising unemployment and that will hurt the residential sector a little bit. I also believe that residential prices will start to ease somewhat because they can’t carry on at the same pace.”
Youguo Liang, managing director of research at Prudential Real Estate Investors in the US, says that while the US market is currently a little more volatile than in Europe, it shares many fundamental market issues.
“Vacancies are at their highest for 10 years in the office sector and they are also high in the residential and industrial sectors. We’re in a consumer driven recession and hotels are suffering and rents have declined significantly. Consequently there has been low demand in the last two or three years with retail as the only exception.”
Liang adds that all the sectors at historically low construction levels, noting that low-level supply is normally good for the investment market. However, he points out that there are other factors at play that will determine whether the US real estate market recovers: “The other good news is that we have not had any demand for all the major property sectors other than retail for more than two years. We expect demand going forward and believe that the job market has bottomed out also, but what matters is how strong the recovery will come in terms of job creation.”
Looking at Asia, Liang believes there are two major factors that suggest the region could be a profitable play going forward. The first, he notes, is that the traditionally expensive Asian office markets in terms of price per square foot in cities such as Hong Kong and Tokyo are no longer running at anywhere near their former highs.
“Prices on rents are much more reasonable today compared to what they can achieve.
“The second factor to consider is that after a 13 year recession, Hong Kong, Singapore and South Korea are starting to show signs of recovery and they are a good recovery play. Prices are reasonable and rents are becoming competitive.
“If the US economy picks up steam then the Asian markets could probably follow and recover.”
In Latin America he is bullish on Mexico: “As the southern neighbour of the US, good economic growth and country management is leading to investment opportunities from industrial to residential and retail sectors. Chile and Brazil are somewhat weaker, but also still good investment opportunities in Latin America.”
Going forward, Liang believes growth prospects in property markets, particularly in the US and Europe, will depend on the relationship between interest rates and the recovery of markets via job creation.
“There could be several scenarios. The first is that interest rates don’t change and there are jobs created, which would be good for the real estate market. The most likely scenario though is that interest rates will go up at the same time as we see job creation, which, although not as good for real estate, is still very important because without jobs you can never move rents, and so on. “Overall, unless interest rates rise sharply we should see a moderate plus for real estate in the next few years and a return to normalcy in the market, ” says Liang.