Investors still overestimating opportunity and underestimating risk

Posted On Saturday, 29 May 2010 02:00 Published by
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The property industry has failed to learn its lessons since the market crash almost three years ago, delegates at the IPD / IPE Real Estate Congress 2010 were told

Speaking in the first session at the two-day conference held at Amsterdam's Okura Hotel, Allianz Real Estate head of investment strategy Joe Valente argued that in light of the debt crisis, which has crippled Greece over the last month, it is no longer certain that we are in the midst of a property, or broader economic, recovery.

Valente told delegates: "I am not convinced the industry has seen the error of its ways. This industry has not seen the light - so when people talk about going back to fundamentals, or basics, or core, I don't believe a word of it."

Market prices, he argued, are driven by liquidity, or lack of it, not fundamentals. "In every single market and sector - whether New York offices or Singapore retail - there is liquidity on the way up, but it is when things begin to turn that the mystical substance called 'liquidity' disappears - just when you need it. It is that which is driving pricing, together with scarcity, it is nothing to do with the leasing market, nothing to do with the fundamentals."

He added: "Property is not difficult - it is not physics or geography - a company takes space and pays rents. Keep your eyes on rents and the leasing markets; we forget that and each time we do we get our fingers burnt. The real beauty of property is that the market moves ever so slowly. One year ago we were all going to die - 12 months on we are doing sub 4% deals in London and sub 5% deals in suburban Frankfurt. Have we learnt any lessons? No we have not."

Valente was joined in the first session by Andrew Wood, chief investment officer at MGPA and Sabina Kalyan, head of European strategy at CBRE Investors. "Many mistakes have been made," affirmed Wood. "I agree with Joe and question what we have learnt and wonder why we are doing some of the things we are doing. Fundamentally, we became over-leveraged and over-estimated what the future would hold and once the growth stopped we couldn't pay our debts. We underestimated risk and over-estimated opportunity. Certainly, recovery is an overused word at the present time."

Kalyan said the debt issues facing Greece are not just a one country, or indeed European, problem. "We are now entering a period where the restructuring of public sector balance sheets is going to be the dominant driver of macro-economic and capital market trends."

Public and private sector debt restructuring

The need for the unprecedented transfer of bad debt from the private to public sector balance sheet was in part due to poor underwriting, which Valente argues "reached an all time low in 2007". When the recovery started to manifest itself, investors seeking leverage had a thin market at best to source debt from, argued Kalyan, and with the British and Irish banks out of the market the pool of European banks was restricted to just the German and large Spanish players.

Kalyan said she was amazed more forced sales had not occurred and that this was a "complete frustration for those of us who are equity investors who want to get back in the market". She argued: "This has led to very bizarre pricing with yields really being compressed for prime assets and a historically very wide gap between prime and secondary yields. One of the big questions for investors going forward is does that differential pricing make sense; does it accurately reflect greater leasing risk and are people just paying silly prices for prime."

She added: "This has created a two-tier market within Europe with massive yield compression in the prime end of Paris, London and far less in the smaller, less liquid markets. Investors are incredibly risk averse - and not just in real estate - which is why gold is priced at record highs and US treasury bills are at record lows."
 
Protracted recovery

The downturn, whether measured in terms of GDP or employment decline, reflected a more rapid decline in activity than we have seen before, Valente went on to argue. "The inevitable consequence of that is that the recovery is going to be pale, anaemic and drawn out."
Prior to the events of the last month, Kalyan said there was "an incipient rental recovery - nothing fantastic - given that the economic recovery was going to be weak, but lending was starting to unfreeze".

She continued: "And then the Greek crisis happened. The eurozone is about to enter a period of deliberately engineered fiscal deflation and that any economic growth forecast that you have seen that wasn't made in the last week is very, very optimistic - to put it as kindly as possible - and the chances of a double-dip recession have increased substantially.

"The good news is that this may come at the same time as a devaluation - if the whole euro devalues - then it would help. It would very much help Germany and the Benelux countries, as the exporters of the region, and it would very much help the real estate markets that depend on that export competitiveness."

In Wood's outlook, he pointed to the yield compression that has taken place in some European markets recently - "some say by too much" - while suggesting that retail rents in particular will decline due to lack of expected consumer spending across Europe.

"In conclusion, uncertainty reigns. And there are outstanding questions; are we actually de-leveraging or do these risks still remain? Do we all understand the risks that lie in real estate? And, crucially, are we still underestimating risk and over-estimating opportunity? I think there is a real possibility we are."


Publisher: eProp
Source: IPD

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