Capital has returned quickly to real estate markets, investment experts say

Real estate capital markets have raced ahead and ignored  distinctions between the fundamentals at work across low growth and high growth countries, according to a mid-year update issued today (Monday 15 August) by LaSalle Investment Management.

Given the nervousness and volatility in other asset classes, most notably European sovereign bonds, Asian stocks, commodity prices and US Treasuries, the relative lack of caution in the real estate capital markets is LaSalle’s biggest worry at the half way stage in 2011.

This has shown itself through intense bidding for core assets in several major markets and through the robust capital raising activities of listed real estate companies, the report says.
 
LaSalle does see justification for the perception among lenders and investors that real estate income streams are now at, or just past, trough levels and are once again climbing, even in the low growth countries.
 
In growth markets, real estate rents and cash flows have been moving upwards rapidly for 12 to 24 months, depending on the specific property type and market. In both cases, LaSalle believes that the capital markets are pricing several strong years of continued growth in the future.

‘The relative lack of caution in the real estate capital markets is a concern. It is remarkable how quickly capital has returned to real estate. The re-emergence of a competitive credit market, so quickly after the bursting of the credit bubble, is also astonishing,’ said Jacques Gordon, Global Strategist at LaSalle Investment Management.

‘Although investing in a capital rich environment is challenging, opportunities for harvesting gains and recapitalizing assets are now much more executable. Also, capital is moving much more slowly in the near core, value add and financially distressed sectors but we still see good value there,’ he explained.

He points out that for commercial real estate, the greatest positive feature of recent capital market volatility is that interest rates are very low and are likely to continue to remain so in all the G-7 countries. ‘The biggest risk to real estate performance lies in timing. Interest rates could move upward well ahead of any major improvements in fundamentals. Real estate yields would then have to rise to maintain the traditional risk premium for real estate, relative to government bonds. And yet landlords might not yet have the power to raise rents, especially if they have locked in long term leases at historically depressed rental rates,’ he added.

The report says that although Japan’s economy has been hit the hardest of the 30 countries LaSalle follows, the reconstruction effort is expected to produce a fairly sharp recovery over the next two quarters. Tenants in the logistics and office sectors are seeking modern quarters in regions with reliable power supplies with a renewed sense of purpose. Their readiness to make major relocation decisions benefits modern stock at the expense of older properties.

It points out that China’s economy shows only slight signs of slowing. In the short run, overheated eastern property markets are at risk of policy changes to reduce or eliminate speculative activity. Central markets and secondary coastal market continue to look attractive.

And in the Asia Pacific region the Australian economy is thriving, thanks to strong commodity exports. ‘The Sydney and Melbourne residential markets are also attractive, especially for urban infill development projects in well-located neighbourhoods. High housing costs, relatively little new construction and a scarcity of risk capital willing to fund new development make this an interesting sector,’ the report says.

In Europe Germany, France, the UK and the Nordic countries offer the best insulation from the financial turmoil in peripheral Europe. Poland is also a rising economy, whose property market is maturing rapidly, it says.

In North America, despite the May/June slowdown in job growth, US real estate fundamentals are still gaining momentum, after a devastating two year stall. ‘The apartment sector is particularly strong, although coastal office markets and the hotel sector are both showing signs of rapid improvement,’ it adds.

It also points out that the Canadian economy escaped a severe recession and so did its major property types. The energy driven markets of Calgary and Edmonton took a sharp hit in 2008/2009 but are now recovering rapidly. And in Mexico the economy has picked up its pace of growth considerably in the last six months. Manufacturing and the Tourism sectors are both rebounding, despite continued security issues in the border markets, it concludes.