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Global Investment Trends: A Return to Fundamentals
03 Mar 2009
To what extent has the situation changed since we last spoke in October?
It has changed significantly. Not only with the worsening of the banking, financial and world economic crisis but also, as far as the UAE and the GCC goes, with the slippage in the price of oil. It has tumbled faster and further than I think any of us could have imagined. I am not an oil expert, but I heard break-even per barrel oil prices discussed at Cityscape Dubai last year. It seems we are now below those break-even points.
This does not bode well for oil producers. In the broader sense, the combined volatility of national economies, real estate assets and oil undermines market confidence for all goods and services. For the first time the recession is global; no country is immune.
The question everyone is asking is where is it going to end, where is the recovery and where do we see some light? The only optimism is that with low interest rates, transportation costs down, generous rescue packages for the banking industry and, in many countries, huge injections of public sector stimulus capital into infrastructure, opportunities will appear in the economic debris.
As for real estate investment, the markets of opportunity will have changed. I suspect GCC investors (private equity, oil money and the sovereign wealth) like everyone else in the world, are experiencing a period of retrenchment. Those who are financially resilient will find themselves in a good position to look around at the markets of opportunity.
Which are the main markets of opportunity?
These too have changed. What we are seeing this year (Q109) is that, while transaction volumes in all markets have slowed significantly, the glow of what had become ‘emerging markets’ has faded more quickly on investors’ horizons. The bloc known as the BRIC countries - Brazil, Russia, India and China - are no longer the constellation of bright stars they were nine months to a year ago. Of the four, Brazil has proven economically more resilient than the other three. The single-party Chinese government has introduced rescue measures to encourage consumer spending and revitalize exports. India, while not so much affected by failed banks, has been hit by corporate corruption but still has a bright future. Russia is having the most difficult time given the falling oil markets and a serious devaluation of its rouble.
The risks and weaknesses inherent in global trade are often exacerbated by currency risks. With fluctuations in the world’s major currencies, many of the emerging markets of Eastern Europe have been hard-hit. As a result, we hear ‘on the street’ that the more traditional, stable markets of the UK and the US are going to prove, going forward, the most attractive to real estate investors. The larger, older, traditional urban trading centres - London, New York, Hong, Kong and Tokyo - will of course remain attractive. They can offer long term strength in terms of space occupiers and rents.
Also, some of the newly emerging cities of Asia and the GCC, especially those that can provide a liveable environment, good harbours and air hubs, good services, low crime and an open business environment, will have long term resilience as the current turmoil subsides. Many will obviously compete strongly with western cities in the future. However, we will always see more opportunistic speculators taking on above-normal risks in emerging markets in the hope of maximizing returns.
Is there still capital coming out of the emerging markets?
With the financial uncertainty, the credit lock and the ongoing banking, stock market and housing crises, central banks and government agencies have found no traction for their stimulus packages, no matter how much bail-out money they inject. It is hard to combat low consumer spending, high unemployment, falling stock prices, currency fluctuations and inflationary pressures purely with massively funded rescue stimulants.
Coming back to the UAE and Abu Dhabi in particular, they obviously have some financial resilience in terms of the oil money and prosperity they have enjoyed over the last few years. No one imagines they are quite in the position that some of the world’s poorer and more depressed markets find themselves in.
However, there is no doubt that effects of the downward global economy on the GCC are severe. A year ago one sensed that the sovereign capital and high net worth individual wealth would continue to be influential leaders in trading of the world’s commodities and assets. There was a feeling in the west that, after everybody else had leveraged themselves to the hilt and institutions had lost a lot of ground on their investments, the GCC funds would perform strongly.
In fact what we are seeing is even those funds, the privately held funds, need leverage. Credit sources are needed alongside equity in order to activate transactions. Classically, no one puts 100 percent equity into real estate investments, even for the best real estate investment opportunities.
At a conference in London recently, the moderator asked for a show of hands from those who thought there would be ‘100 percent equity deals’ this year (2009)? Not one person put up their hand; meaning that no matter how much individual wealth there is, it is credit and leverage that oils the wheels of the market. It is clearly an essential catalyst for the investment. Today’s deleveraging trends are an obstacle to market activity.
From that point of view, as long as the western world’s banking crises continue and the credit situation remains unresolved, the lack of market confidence and the uncertainty will continue. This means quite simply, a frozen real estate investment market which meetings such as Davos and G20 are powerless to thaw.
Overall, I see very little happening in the world’s investment real estate markets over the next six months. Even if opportunities arise, I don’t think investors are going to be in a position to take advantage of them. This is proven by the data shown in the Real Capital Analytics (RCA) Global Capital Trends report (February 2009). While the transactions tracker shows a very low volume of transactions, the RCA troubled assets radar shows a growing inventory of properties where either the owners, the tenants or the properties themselves are potentially distressed.
The growing interest in these trends means, I suppose, that many investors are already preparing and targeting opportunistic properties and doing their due diligence. Some investors will be very ready to re-enter the markets when they think the bottom has come. But not everybody is going to see where the bottom is.
That is one of the exciting things. If you call what you think is the bottom and you are ahead of the game, then you will do very well. But the sense at the moment is that you are catching a falling knife and it hasn’t dropped to the bottom yet. That applies to the residential market as well as the commercial market.
How do you think financing will change in the future?
I foresee financing in the future becoming a lot simpler. I think the banks will be very conservative as they begin to lend again. The appetite for securitisation over the next two or three years will be muted. I can see investors being reluctant to buy pieces of paper that have only a distant interest in say the secured debt on a property. Instead, they will want closer access to the underlying asset. Advisors will have to work harder and be more transparent to convince investors that the asset is worth what they are paying. Investors in other words, are not going to be eager to buy paper without seeing and getting a feel for the property itself. Diligent investors coming into a US city, for instance, are going to want their representatives to see the shopping mall, office building or factory and talk to the tenants; to actually do some very hands-on due diligence. They are going to take a really hard look at what they are buying in terms of the bricks and mortar.
At the same time, valuations will be more transparent and, at first, more conservative. The true measure of value will simply be a capitalization of the net cash flow from the rent. The cap rates or yield applied to the net operating income (NOI) from a property will also be conservative.
The way we value real estate will simplify. There can be no complex algorithms and projections using income in five years’ time to establish today’s value. The speculative element has gone. Transparency is back. Accurate valuations can only evolve if there is a greater willingness between investors and advisors to share data.
Valuers will be in the spotlight and perhaps more heavily scrutinized. Their decisions after all will decide who wins and who loses in the high-stakes recovery game. Decisions about whether to foreclose or whether to hang in for a recovery are often based purely on the valuation.
On a broader front, I think we will see REIT’s come back fairly strongly. People will be inclined to invest in well-managed REIT stocks, where the share value is less than the net value of the actual asset. But again so much depends on value. At present, there is no agreement as to what the value really is. So investors and lenders are going to be very cautious at first.
Having said that, I think in three years’ time (or perhaps as long as five), we may surprised to find that markets have recovered - at least in pockets. Then the whole cycle will begin again. We’ll see CMBS securitisation, derivatives and synthetic investments recover as if nothing had happened. From my experience of a couple of recessions, I have seen people pull in their horns, be very conservative for two or three years until the pain subsides. Then it all starts off again into another cycle of spending and speculation.
You mentioned back in October that you thought there were going to be more public/private partnerships and a greater degree of collaboration. Do you still agree with that?
Even more so. The reason it is increasingly important is because, as part of their rescue packages in many countries, governments will be taking interests in real estate assets and the banking industry. So the public sector will have a growing vested interest in their investments. They are going to have to appoint watchdogs and people to manage these assets and make decisions in collaboration with the private sector.
One of my recommendations for recovery is to combine the best of the public sector, the best economists and think-tanks, and the best brains from the private sector. While I agree we need some enforcement and accountability, government leaders should not spend all their time pointing fingers of blame. The way forward is to share ideas, pool resources and work together on finding solutions.
Public-private sector collaboration is absolutely essential if we are going to get out of this. Neither government nor can the private sector can do it alone – they need each other.
Do you think there need to be more stringent international standards for valuations?
I have been asked by the RICS to write a paper called ‘A Vision for Valuation’ which absolutely recommends a more international approach to valuation. This will mean the calibration, recognition and qualification of appraisers worldwide. Appraisers involved in putting values on cross-border assets should have a global qualification. There should also be some form of agreed international standards and global enforcement of ethics.
Unfortunately that is like saying there should be world government. There are so many different cultures, method and procedures, there is clearly not going to be a one-size-fits-all valuation standard worldwide. A start could be made with the nations where there is investment activity. They should collaborate to recognise each other’s qualifications, agree standards for education, find ways of making transaction data more transparent and agree to a consistent set of valuation regulations.
What I say in my paper is that in the past decade, markets have been battered by the three forces of urbanisation, globalisation and securitisation. We have to find new ways of ensuring the reliability and credibility of asset valuations in these changing and uncertain markets.
If there isn’t sufficient evidence to say that the value is 100 percent certain, then the valuer shouldn’t be afraid to say that the underlying assumptions are uncertain. For example, they may say the reliability is predicated on the assumption that the major tenant is going to renew the lease.
What we have seen in the last six months is the fundamentals, the core drivers of real estate, the tenants themselves and the occupiers have shrivelled in their need for space because there has been corporate downsizing. You may have a major law firm or accounting firm in your building and you think you’ve got Merrill Lynch or Lehman Brothers but that has all changed; only recently Lehman vacated 350,000 sq ft in Canary Wharf. So what looked like a good lease collapses in a down market.
I think going forward we have to look at the durability, stability and reliability of the leave covenants because that bottom has dropped out of the market. In this way, the valuer can evaluate the risk within the appraisal. To wait until the investment collapses and then retrospectively measure the past risk, is unacceptable. The investor wants to know these things upfront, before he/she invests.
So I think the valuation profession can be a lot more straightforward and honest. It is better to reveal the true nature of the risk to the investor client than to sugar-coat the pill and subsequently face more difficult consequences. This is all part of a more transparent market where decisions are based on accurate data and the independent interpretation of facts.
Source: Cityscape Intelligence