Ernst & Young EMEIA Real Estate Workshop
Here are my notes from the excellent E&Y Workshop I attended recently.
Bid-ask spreads narrowing
Transaction levels rising
Sir John Gieve (former Deputy Governor of the BOE)
The uncertainty is still there because:
Economic forecasting models are broken
Prediction: big swings in market sentiment & lots of volatility in the markets Currently fiscal (spending) and macro-prudential (regulation) brakes on while the monetary (interest rates, QE) accelerator is firmly on Expectation that private sector investment, consumer spending and emerging market growth will pull the UK towards around 2% GDP growth in 2011 MPC likely to be cautious about raising rates early in 2011 but if growth continues throughout the year then rates could rise faster than the market currently expects (to somewhere between 3-7%) Emerging market economies in particular the Chinese likely to lead to a big inflationary boom that spreads to the West through commodity prices
Adrian Cooper (CEO, Oxford Economics & ITEM club advisor)
World GDP growth is outstripping already relatively bullish forecasts North and South Europe dramatic divergence in growth and prospects German competitiveness has improved significantly over last 10 years whereas southern European states have become significantly les competitive as labour costs have risen Fiscal tightening and divergence in investment will also hold back the Southern economies for a prolonged period c50% chance of Greek debt restructuring and/or smaller chance of some form of Eurozone breakup Other notable risks include oil and commodity inflation and recognition of Spanish debt/losses as a result of their boom time lending to construction In the UK massive switch in govt spending worth around -1% on annual GDP growth Household de-leveraging to hold back growth further Rising exports will help though past failings in exports to emerging economies (Italy exporting more to the BRICS than the UK for example) Modest growth forecast in office-based employment and consumer spending leading to limited demand growth in offices and retail property High single-digit total returns expected for prime commercial property
Huge demand from the Middle East for construction and infrastructure but there are major risks around political risks as a result of underinvestment in food, healthcare, education, employment and social stability.
If we can see civil unrest in the UK then we can expect to see unrest in other states as austerity measures start to bite.
US deficit is not expected to be a major threat in the next couple of years but it will be in the longer term – the UK had the same problem when it ran the reserve currency and that held us back for 50 years after the second world war Currency disparities and interventions make life difficult for global Investors seeking to hedge out risks Pension funds slowly increasing allocations to real estate but notably focussing on core assets and focussing increasingly on specific cities rather than whole countries Negative real interest rates could lead to a bubble in some asset values. Highly leveraged investors even in core assets are at risk from interest rate rises designed to combat high inflation Euro stress tests back in July showed 84 out of 91 banks were well capitalised including the 2 largest Irish banks which are now bailed out. This will prove a drag on the economic recovery and it will take quite a long time to relieve c50% of maturing real estate debt is underwater and although resulting opportunities are few and far between they are worth looking for
Drivers of Real Estate Panel
Property looks more interesting than bonds but less attractive than equities (Harm Meijer, JPM) Lots of inflows to direct investment funds moving out of bonds (Harm Meijer) JPM are positive on property, more prime but starting to find opportunities in secondary Institutions are currently underweight in property and increasing their allocations. Increased inflation driving this demand as they look to protect themselves. Harm Meijer is astonished that they are coming so late to the party Trust issues will endure for years ahead while funds re-align their interests with LP’s and increased co-investments are demanded UK retail funds raised a lot of money in Q1 2010 and 2007 opportunity funds are all sitting on a lot of cash but is there a bubble in prime and super-prime and do return expectations need to come down.
“If you look at what is happening to real estate, it is exactly what happened in 2007 and 2008 when cap rates were plunging and LTV’s were going up without cash flows”. (Starwood Capital Chairman & CEO – Barry Sternlicht) Caveated with in certain prime sectors (Doug Kirkman, Blackstone) It’s probably the best time in living memory to setup a bank because margins are very high and lenders can pick their borrowers and properties.
Existing lenders cannot afford to take the losses on existing loans so they are very limited in their capacity to lend. Particularly in the UK where there is still no securitisations market in contrast to the US which has begun to close some and is expected to increase this flow.
Insurance companies may increasingly likely to enter the market (Solvency II will encourage them to do so) but it will take them time to build their teams and they are unlikely to buy up existing debt portfolios.
According to Knight Frank 2010 occupier take-up in Financial Services in the UK was actually higher than during the boom years however this is substantially offset due to impending lease expiries and competition from Internet based businesses etc so net absorption and rental growth is likely to be quite limited and generally restricted to prime.
London and Germany are relatively booming whereas regional locations are really struggling.
Supply of product is going to be slow while the clearing prices continue to sit below the holding values and supply of debt is highly restricted and it is likely to take some years before big non-performing loan books really come to market due to political debates around bank break ups etc.
Sustainability – opportunistic investors are less interested in this than price etc however pension funds are pressuring listed owners and occupiers are increasingly expected to demand higher standards.
Increased transaction activity is expected though only by around 10-20% and from a relatively small base.
Banks will have to extend and pretend until deals break and have to be dealt with or they have generated sufficient profits for their capital base to enable them to take losses on existing holdings.