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Déjà vu: The School of Bad Times

March 31, 2016

Congratulations class of 2015, you have graduated from another real estate cycle. What have you learned?

 

As children, the first eight years of our lives are perhaps our most formative period. In this relatively short time we develop linguistic, social and cognitive skills that are the basis of our learning for the remainder of our lives. In stark contrast, eight years in the marketplace can seem like it has hardly made a difference.
 
It seems only yesterday that the world economy – and with it the property market – was on the brink of collapse. The implosion of the financial markets in late 2008, and the recession that followed, had a profound impact on the property market. As the party drew to a close, the remaining banks and peak investors were left to clean up the mess. Banks – the drivers of activity and the public scapegoats of the downturn – took a U-turn, going from the commercial equivalent of NINJA-residential mortgages (no income, no job application) to a total crackdown on underwriting procedures and a massive hike in lending requirements.
 
For a short while things seemed to have reached a new normal: more responsible lending practices and seemingly cautious investors, less eager to venture into speculative opportunities and new markets.  However, what goes around comes around, and we seem to be reliving 2007 all over again.
 
Property consultants all agree that 2015 was a record investment year for European commercial property, with just short of €250 billion commercial property changing hands. Prime yields in many core markets, most notably London, Berlin and Paris have reached or exceeded levels recorded in the previous peak. Private and public investors across several sectors boast that they have broken their own investment records. To name but a few examples: with €4 billion transactions in 2015, AEW Europe acquired twice the volume it did in 2014, while Rockspring invested €270 million within just three months of funding their new TransEuropean fund. 2016 promises to be another record year - a survey of global institutional investors suggests that they will allocate a further €48 billion to property in 2016, 13% more than 2015.
 
Debt has again taken centre stage. As banks continue to write down their losses from the previous cycle and savvy debt investors look to turn a quick profit, there is a boom in (commercial) loan sales: a record €86 billion of loan sales took place during 2015. The record may well be broken again in 2016. With low interest rates and disappointing performance of stock and bond markets, property’s popularity is likely to persist – if only for a little while longer.
 
This begs the question of how much steam is left. Prime yields have stopped compressing in most markets. Investors are increasingly looking at secondary markets and calling for prudence and discipline in investment decisions. Fewer investors are willing to do transactions that will set a new yield precedent.
 
This cannot allay the feeling that the current cycle hasn’t quite lived up to the grand reputation of the previous one – both on the way up as well as on the way down – everyone seems to have behaved a bit more responsibly this time round. Cautiousness and uncertainty (even confusion) has dominated decision making in the current cycle. If the cycle that topped in 2007 was a month-long rave party, the current one is a romantic candle-lit dinner for two on a depressing mid-January evening.
 
So what have we learned? Certainly not as much as an eight-year-old child. With another cycle gone, another eight years’ worth of experience, and over a billion Euros of real estate transactions completed, we have simply reaffirmed the three basic rules of real estate: location, location, location. Apart from that, the myopic obsession with trivial return measures such as the internal rate of return, and the pathetic impermanence of quarterly and annual performance reports, seems all we are able to hold on to – hoping that these tools will give us a different result next time round.
 
* sources: JLL, CBRE, Cushman & Wakefield, INREV

 

 

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