The real estate of things to come

James Wilkinson, manager of the Thames River Property team, explains why long-term opportunities for listed real estate are more positive now than before the credit crisis.

We have long held the shape of real estate returns is attractive over the long term and real estate also offers diversification benefits within a multi-asset portfolio. Of more immediate importance, however, we now think there are particular reasons to be positive towards the sector at the current time.

Listed real estate companies are almost all on a sound commercial footing. Balance sheets have been restored where necessary and revenue accounts are generally founded on relatively long leases and loan durations. Vacancy rates, levels of bad debt and tenant delinquency have risen far less in the last few years than during the property crash in the early 1990s, meaning absolute revenue levels fell less from peak to trough than was expected.

Concerns

One of our main concerns for the property markets over the last few years was commercial real estate (CRE) debt refinancing. We worried the scale of debt maturing between 2009 and 2013 was such that it would swamp available debt and equity, leading to a further plunge in property values. Not only has this not happened but we are now confident it will not materialise at all.

We believe as the full horror of the credit crisis reverberated throughout 2007 and 2008, the main lending banks had very little idea of what they had to deal with within their property lending books. Real estate loan books were effectively frozen while banks put their houses in order, and this may well have prevented losses within commercial property markets.

Since 2009, UK real estate values have recovered approximately 15%-20% from their trough (44% peak to trough fall according to UK IPD) and this significantly reduced the scale of the CRE debt refinancing issue. Furthermore, DTZ now estimate there is $145bn of equity available for investment into European commercial real estate between now and 2013 compared to a debt funding gap (DTZ define this as the difference between the existing debt balance as it matures and debt available to replace it) of $126bn.

Auspicious signs

These statistics bode well for real estate investment markets. That is not to say the path will be entirely smooth. Investment demand is likely to be focused on specific markets and sectors, which will not necessarily coincide with where the debt needs to be refinanced. Similarly, equity investors are not always prepared or able to take over real estate loans or to participate in joint ventures.

Important issues

However, the really important issue is what we once viewed as an almost insurmountable problem now appears to be solvable. In the usual way, market pricing will differentiate between high and low demand areas of the market. Yields in low demand areas may have to rise further until there is sufficient demand. This, however, is a normal market – something we have not seen for many years – and the corollary is yields in high demand areas will fall, meaning values will rise.