Making A Case For Global Real Estate
Coverage of the 2010 Global Investment Conference
BY Max Swango, Invesco Real Estate | August 23, 2010
In the context of a multi-asset investment portfolio, real estate provides several advantages, including: (i) Competitive total and risk adjusted returns, (ii) High income yield, (iii) Diversification, (iv) Potential inflation hedge, and (v) Represents a meaningful share of the investable universe. When compared to other asset classes over the long-term, direct real estate provides attractive risk adjusted returns. For the 3-, 5-, 10- and 15-year periods, the NCREIF Property Index outperforms the MSCI World and Barclays Global Aggregate Bond Index on a total return basis. Additionally, real estate historically provides a high relative cash return to investors. In addition, private real estate investments can offer investors advantageous portfolio diversification with low correlations to other asset classes, including global equities, bonds and U.S. Treasuries. Finally, real estate represents approximately 8% of global market capitalization as of December 31, 2009, providing a significant investable universe for global real estate investors.
Based on the belief that the worst of economic times are behind us, investors have become more active in pursuing core real estate in primary markets. More than two years after the fall 2007 peak in U.S. commercial real estate prices, we believe that pricing of institutional quality properties is at or close to approaching a floor.
The recent movement of capital back into the commercial real estate sector is in response to the steep price declines that have already taken place and reflect an expected recovery in fundamentals, thus providing support to current pricing. The ability of pension funds, REITs and private equity to raise capital over recent months demonstrates that capital is moving back into commercial real estate. Investors are attracted by a number of pricing dynamics today. For example, the gap between transaction cap rates for institutional-quality real estate and risk-free Treasury yields currently is the widest on record. Historically, investments made during periods of wide cap rate spreads have, on average, produced investment returns above long-term average rates. In addition, real estate prices and valuations have fallen to levels last seen several years ago, providing an attractive basis for investment capital. Prices as depicted by the Moody’s/REAL Commercial Property Pricing Index (CPPI), a same-property repeat-sale transaction price index, experienced a peak-to-trough decline of 44% (November 2007 to October 2009) to levels last seen in 2002.
We believe that a recovery in property market fundamentals will gain momentum in 2011. Our expectation of improving job conditions should lead to healthier tenant demand in 2011. Additionally, construction lending has all but evaporated, given current banking conditions and today’s lower occupancy and rent levels. Taken together, 2011 appears to set up favourably for property fundamentals to improve. Given that a rebound in tenant demand typically lags employment recovery and that sustainable employment gains are not anticipated until the second half of this year, we expect further declines in real estate revenues in 2010. Offsetting weak tenant demand this year is the lack of new construction starts due to the shutdown in lending, thus lightening the weight of supply as tenant demand strengthens. While fundamentals could see more stability in the second half of 2010, more noticeable improvement may not be evident until 2011.
Anticipating better fundamentals, investor interest in commercial real estate has increased in recent months, but asset pricing is sharply bifurcated between core vs. non-core risk. Intense interest for high-quality assets in primary markets that have a more favourable employment outlook has driven cap rates lower and prices higher. In contrast, riskier assets and markets are trading at lower prices and higher cap rates, reflecting substantial aversion to above-core risk attributes.
These are the personal views of the presenter and not necessarily the views of Invesco. Forward-looking statements are not guarantees of performance.
Source: Invesco Real Estate, NCREIF
Max Swago is Managing Director with Invesco Real Estate.