Solid foundations

Crystal ball-gazer Eric Rosedale says the real estate sector is looking strong.

The first half of 2011 has seen a robust recovery in real estate investment activity with much of the transaction volume concentrated in primary global financial centres, in both developed markets and the Bric (Brazil, Russia, India and China) countries.

Globally, property markets surged ahead with investment volumes reaching peak 2007 levels for the first time in five years, and more than 40 per cent ahead of 2010 levels. Capital values are also resurgent, rising more than 20 per cent in a number of major markets.

Emerging markets continue to move from strength to strength and take larger shares of global real estate transaction volume. According to a recent report from Jones Lang LaSalle, the Bric countries’ share of global real estate investment volume has risen to 13 per cent in 2011 from just 2 per cent in 2007.

Emerging markets are now expected to grow three times faster than developed markets, with China maintaining its perennial dominance with growth estimated to be in the range of 9 per cent in 2011.

European real estate trends have been on a steady upswing, with annual volume predicted to reach €135bn (£119bn) this year. Germany, the UK and France continue to dominate Western European real estate markets. In Germany alone, transaction volumes are predicted to reach more than €20bn, a nearly 25 per cent increase over 2010 levels, with the retail investment sector predominant.

As prime yields continue to shift downward in Western Europe, investors have been seeking value-driven investments in Central and Eastern Europe and this has boosted activity in the region, particularly in Poland and Russia. Remarkably, CEE property investment climbed 180 per cent to €4.4bn in the first five months of 2011, mainly driven by German, Austrian, UK and other foreign investors who accounted for 80 per cent of the deal activity in the region.

The outlook in the US and selected real estate markets in Latin America has also been positive since the second half of 2010. Advances in the Americas are particularly impressive at 125 per cent over 2010 levels, although this growth is coming from an extremely low baseline.

In the US recent improvements to property values in top urban markets are finally encouraging banks to put large distressed portfolios on the market, raising the prospect of a sustained pipeline of attractively priced assets matched by a modest recovery in real estate lending and securitisations.

In spite of all the positive indicators, the tail winds propelling global real estate markets are bumping up against a disturbing and unpredictable list of “tail risks”. This list starts with massive unresolved sovereign debt problems and high levels of unemployment in the US and Europe and goes on to include aftershocks from natural catastrophes, oil price super-surges, political turmoil in the Middle East, and a property bubble waiting for a pin in China.

These tail risks are in the hands of politicians and central bankers, as well as being acts of God, making it extremely difficult to predict the impact they will have on the resurgent global property market. Clearly, former risks in global property markets could return if a new financial crisis is triggered.

For example, there are €950 bn of outstanding commercial real estate (CRE) loans in Europe of which €530bn become due by 2013. In the face of this massive re-financing wall, there has been a small but growing and diversified mezzanine loan market building. A shock emanating from a tail risk could trigger a collapse of the CRE loan market which in turn would damage or even destroy the nascent European real estate market recovery.

Another effect of unresolved tail risks on global real estate markets could be to halt or reverse the recent trend of global real estate investors moving up the risk curve. The combination of yield compression, lack of supply in core real estate markets and, ironically, growing confidence in a broad economic recovery could lead to a significant decrease in real estate investment volume as investors take a “wait and see” approach. There is already an indication that this is occurring as property investment in Europe and Asia has slowed in the second quarter of 2011.

Real estate private equity investors are understandably more cautious since the financial crisis and this could have an exaggerated effect on their real estate investment decisions. According to Preqin there are 435 private equity real estate funds in the market seeking to raise $148bn (£90bn).

While 18 real estate funds reached a final close and raised €7.7bn in the second quarter of 2011 – still well below 2006-2007 peaks – and the average fundraising period has been reduced, the slowly improving real estate private equity environment could deteriorate if sovereign debt defaults or other tail risks materialise this year.

Of course every tail risk presents an investment opportunity in some segment of the global real estate market for savvy, long-term investors positioned to ride out an increasingly unpredictable world.

Eric Rosedale is co-chairman of Salans global real estate group