Friday, October 12, 2012

Betting Big on Global Real Estate?

Jeffrey St-Onge of Bloomberg reports, OMERS’ Oxford Properties plans $3 Billion Toronto Project (h/t, Caroline Cakebread):
Ontario Municipal Employees Retirement System’s Oxford Properties said it may invest more than US$3 billion in a downtown Toronto development.

The project, one of the largest urban redevelopments in North America, includes a renovated and expanded convention center, hotel and casino complex and a 5.5-acre urban park, Toronto-based Oxford Properties said in statement Friday. The site is on the south side of Front Street, bounded by Simcoe Street and Blue Jays Way.

“If the decision is made to have a casino in the City of Toronto, Oxford believes it can provide the best location and the ideal solution for all stakeholders,” Oxford Properties Chief Executive Officer Blake Hutcheson said in the statement. “Oxford Place is a well-conceived private sector solution that requires no public infrastructure or other funding and drives significant community benefits.”

Omers, a pension fund manager in Canada’s most-populous province, posted a 3.2% return on investments last year, led by private equity, real estate and infrastructure holdings the fund said in an earnings statement. It invests in real estate and manages more than $55 billion of assets for more than 420,000 retired and active municipal employees in Ontario.

The development would be called Oxford Place and also includes renovation of Metro Toronto Convention Centre. Architectural firm Foster & Partners will be responsible for the master plan, Oxford Properties said.
The Financial Post provides more details on this deal. Now, leaving aside my distaste for casinos and how they cater to people's vices and weaknesses, I led off with this article to demonstrate how pension funds are betting big on real estate.

I happen to think Toronto is in for nice pullback in residential and commercial real estate but the experts at OMERS' Oxford Properties obviously disagree as they're willing to invest $3 billion into a casino project in downtown Toronto.

Tara Perkins of the Globe and Mail reports that real estate generated $63.3-billion in economic activity in Canada last year, making the sector’s economic contribution twice as large as the entire economy of the province of Newfoundland & Labrador, according to a new report:
The Real Property Association of Canada (REALpac) and the NAIOP Research Foundation, two groups that represent the commercial real estate industry and advocate on its behalf, asked Altus Group Economic Consulting to prepare the paper, which will be made public Wednesday morning.

It seeks to quantify the contribution that the sector is making to the nation’s economy, and it suggests that the sector supports almost 340,000 jobs, roughly equivalent to the total employment from the country’s entire agricultural industry.

The total economic activity that the sector generates includes new construction, improvements to existing buildings, brokerage activity and property management, and the spinoffs of that.

The report pegs the sector’s contribution to this country’s gross domestic product at $32.4-billion, and says that it generated about $18.1-billion in personal income for Canadians last year, and $12.5-billion in profits for businesses.

No doubt about it, real estate has been a hot sector in Canada for as long as I can remember, but as I have been warning, the Canadian housing bubble will burst leading to a spike in unemployment:
A slowdown is coming to Canada’s construction industry, thanks to the cooling housing market, says a new report from the Conference Board of Canada, and the result of that could be a significant spike in unemployment.

The Conference Board predicts a “soft landing” for Canada’s housing market, but warns that the construction industry will see a grim 2013.

“The residential market … will no longer be able to fuel Canada’s post-recession growth,” Michael Burt, director of industrial economic trends for the Conference Board, said in a statement. “Next year is expected to be particularly lacklustre, as housing starts and industry profits are both forecast to decline.”

A slowdown in construction activity would inevitably lead to higher unemployment. With consistent growth in home prices for the past decade, and a condo construction boom in recent years, concentrated primarily in Toronto, Canada’s economy now relies on construction jobs more than it has in at least the past three decades.
I know the economists at the Conference Board and have the utmost respect for them, but let me tell you, when the construction boom turns to bust in Canada, it won't be a "soft landing". It's going to be hell. The only thing giving me some solace is that the US recovery is gaining momentum and I think Europe, China and rest of the world are turning the corner. This will help cushion the blow.

But as skeptical as I am on Canadian real estate, I'm bullish on US commercial and residential real estate. Smart money has been scooping up properties at fire sale prices over the last couple of years. And even in the US, skeptics abound. The Urban Land Institute cut its forecast for U.S. commercial real estate sales by 12 percent to $748 billion through 2014 because projections for economic growth are “down considerably” from six months ago.

With all due respect to the Urban Land Institute, they don't have a clue of what is going on in the US economy (reading too much Zero Edge?). Employment growth has been sluggish but it's gaining momentum. Once you see 200,000+ jobs figures in  monthly payrolls, the demand for commercial real estate will pick up significantly, and so will bond yields.

In fact, it's already happening. World Property Channel reports, New York City Still 'Top Dog' of Global Property Investment Marketplace; London and Tokyo Ranked Second and Third:
According to Cushman & Wakefield's annual Winning in Growth Cities report launched today at EXPO REAL trade fair in Munich, low global interest rates and ongoing risk are luring investors towards commercial property markets in core global cities, with New York attracting the most investment during the last year.

The top 25 global cities have in fact strengthened their lead in the past year - increasing their market share to 56% from 46% in 2009. However while this dominant group will continue to be favoured by investors for their risk averse characteristics, they will in the future face increasing competition from a host of other cities according to the report.

Cushman & Wakefield's report highlights include:
  • New York is the largest global investment market for second consecutive year - with volumes rising 18.9% to US$34.7 bn in the year to Q2 2012
  • London took second place with 3.8% growth in investment volumes to US$ 29.3 bn (18% less than New York)
  • Tokyo, Paris, Los Angeles and Hong Kong round out the top 6. Los Angeles took top spot for investment in industrial, Shanghai for development sites and Hong Kong for retail.

Glenn Rufrano, President and Global CEO of Cushman & Wakefield tells World Property Channel, "True global cities have gone from strength to strength in the past year, and the investment hierarchy is now well defined. However, the top targets are really 'safety first' choices and will be challenged when recovery comes. In our opinion the hierarchy will in fact expand as cities mature, higher quality property is developed in emerging locations and crucially, as occupiers lead the way into new markets."

A continued strong focus on mature, core liquid markets by investors seeking future growth potential but also better stability and liquidity has seen the top 25 cities increase their importance, with volumes rising 6% versus a 0.8% increase in the market overall.

Boosted by higher yields and higher yield premiums, liquidity and transparency, North America dominates the top rankings, with 15 of the top 25 targets and 17 of fastest growing in the past year.
Asia is the second strongest region in the top 25, with 6 current targets and 5 high growth markets. There was little change in the top 25 ranking with 21 of the top cities the same as last year, with Sydney, Seattle, Phoenix and Denver moving up at the expense of San Diego, Hamburg, Melbourne and Beijing, the latter of which lost out due to a slowdown in land sales although it is likely to recover.

Concerning investment by property sector, the office market attracted the most investor capital, accounting for 43%, followed by retail (20.8%), residential (18.1%), industrial (10.3%) and the hotel sector (7.2%).

Global flows of cross border capital reached US$150 billion in the 12 months to Q2 2012, a rise of 4.3% on the same period in 2011. London topped the table for the overseas investors for the second year at US$19.6 billion, with Paris some way behind and New York in third spot. Tokyo and Hong Kong are the top two Asia Pacific cities slotting for foreign investment, in at fourth and fifth respectively.

Strong performance in major global property investment markets continues despite 8% total volume decline compared to same period in 2011, according to preliminary numbers from Jones Lang LaSalle:
Despite a slight fall on the US $106 billion total recorded in Q2 2012, transaction levels have held up in the summer months of Q3. This is due to strong performance in established major markets in all three regions, such as the United States, UK, Germany and Australia.

Arthur de Haast, Head of the International Capital Group at Jones Lang LaSalle said: "Whilst general sentiment continues to be constrained by the economic environment, transaction volumes have been robust overall for the last quarter due to high levels of interest in offices, retail and industrial real estate in major global markets.

"Investors have been placing capital in the major cities in these safer markets. These larger markets have more liquidity and lower risks and whilst returns might not be as attractive as emerging markets such as Brazil, India and China, these economies have slowed and market transparency is lower.”
David Green-Morgan, Global Capital Markets Research Director said: “Whilst investors are still being cautious and deals take longer to complete, there is a reasonably solid outlook for the rest of 2012.

"Financing for real estate transactions shows signs of improving in the US with CMBS issuance set to surpass the levels seen in 2011 and debt levels are steadily coming down, demonstrating that refinancing activity is taking place. Government quantitative easing and central bank policy activity has also improved global liquidity and confidence."

Arthur de Haast added: "Q4 is historically the busiest quarter of the year and that will be no different this year for real estate transactions. Whilst global investors might be watching the upcoming US presidential elections with interest, we expect this to have limited impact on activity as proved the case with the recent London Olympics.

"Looking further forward we expect volumes to increase in 2013 and one trend to watch is the continued activity in alternative sectors, where our teams are currently extremely busy."

What is driving much of these global flows in property markets? Sovereign wealth funds and pensions funds adding more risk as they shift assets into illiquid real estate to meet their actuarial return targets.

And it's not just a New York, London and Tokyo story. CNBC reports that Singapore’s property stocks have surged on average 48 percent so far this year, far outstripping the 15.5 percent gain on the broader Straits Times Index, and analysts say there is still more upside for the sector. Demand for commercial office space in Dubai is matching levels seen in 2007, signalling that even overdeveloped markets are showing signs of a rebound.

Of course, much of this growth is once again driven by liquidity, not economic fundamentals, a point underscored in markets like Taipei where real estate prices are set to peak next year:
With liquidity still abundant, commercial real estate properities in Taipei may see selling prices peak (or climb higher) next year while the global ecocnomic slowdown constrains the leasing market, a Jones Lang LaSalle's director said yesterday.

The remark came after Jones Lang LaSalle — a financial and professional services firm specializing in real estate — released its latest survey for the Taipei Grade A office market.

The vacancy rates and rents for Grade A offices in Taipei generally remained flat in the third quarter from the second quarter, the report said.

The average vacancy for Grade A offices in Taipei dropped to 10.07 percent during the July-to-September period, a slight decrease of 0.1 percentage points from the April-to-June period, while rents remained at NT$2,387 (US$81.50) per ping (3.3m2) per month in the third quarter, similar to that of the previous quarter, the report’s data showed.

However, total take-up fell considerably, from the 12,445 ping recorded in the second quarter to 782 ping in the third quarter, as the depressed global economy pushed corporate tenants to adopt a wait-and-see stance.

INVESTMENT

On the investment front, the total transaction volume of commercial real estate in the third quarter amounted to NT$54.7 billion, up 82.5 percent and 7.16 percent from a quarter and a year earlier, according to the report.

“The slowing leasing sentiment in the Taipei Grade A office market showed the current trading momentum and prices for office buildings were mainly supported by abundant capital, instead of economic fundamentals,” Jones Lang LaSalle managing director Tony Chao told a media briefing.

The situation may cause momentum in trading prices for commercial properties to peak in the near future, Chao added.

Chao said momentum of trading volume may continue to support the commercial market steadily, with Taiwan’s financial and insurance institutions remaining the most active investors.
Clearly there are regional differences in commercial real estate that will impact prices and yields. Even in the hot UK property sector, there is now a significant pick-up in secondary market activity:
As the UK commercial property market becomes increasingly polarised and wealth continues to pile into central London locations, is value now emerging in the secondary market?

Marcus Langlands Pearse, manager of the Henderson UK Property unit trust, says that with few competing buyers and plenty of forced sales, prices are at previously unheard of levels in the secondary market, although he warns the quality of the property has to be examined very carefully.
Unprecedented yields

‘Prices are very uncertain, it’s hard to predict the price of a sale,’ he says. ‘You are seeing 10%-12% yields and actually if you get a forced sale situation it’s a 15%-20% yield. We are seeing double-digit yields that I haven’t seen before in my professional life.’

He cited a recent office building in central Birmingham that was being sold at a yield of 15% plus with seven years left on the lease, as an example of the bargains to be had in the secondary market.

‘If you look at a building like that and you look at the capital value of some of those buildings, it is impossible to buy a site and put a building up for the money an investor in that kind of property is going to pay,’ he said. ‘When you see how far yields have moved, if you are a long-term property investor and pricing in your capital expenditure, I think there is value emerging in those markets.

‘There are now an increasing amount of players who would have been looking at prime and who are now seriously looking at short to medium-term income where values have been severely discounted.’

Moreover, while money pours into the seemingly bullet-proof prime London locations, Langlands Pearse argues that the sector is dogged by less than optimal occupancy rates. ‘This is exactly why we haven’t been investing hugely in that market. It has been very much an investment market, it’s not an occupancy market,’ he said.

Langlands Pearse has been buying retail space on Edinburgh’s Princes Street – the Scottish equivalent of Oxford Street – and invested in a Midlands Tesco store with 14 years remaining. He has also opted for properties with super-long income streams, buying a hospital in Poole with 27 years remaining on the lease.

He has bought into a car showroom let by Sytner BMW. ‘The rent is indexed there as well so in a way we are proofing the income against inflation,’ he said.

Threadneedle’s UK Property Trust manager, Don Jordison said investors had placed too much emphasis on the death of the high street and struggling retail occupancy rates. ‘We look at the distressed market because property is nothing if not entirely schizophrenic, all the time,’ he argued.

‘On the one hand, we have the highest prices being paid for little bits of London, but at the same time, I can buy property that has never been as cheap as I have seen in my career. I would rather be buying historically cheap prices than going into uncharted territory on historically high prices.’
High street retail undervalued

He added that people had been talking about empty shops for decades, but some areas were still doing well, with sovereign wealth fund Norges recently buying up around half of Sheffield’s Meadowhall shopping centre.

Jason Baggaley, manager of the Standard Life Investments Property Income trust, said he expected property values to continue to fall through the final three months of the year, but longer term he is positive on the outlook for the secondary market and is taking positions in properties with shorter leases.

He has recently bought up a grade-A office in central Glasgow’s West George Street, with low rent of £17 a square foot and a yield of 9.5%.

‘We have let one floor that was empty so we have already seen performance, and the purchase price that was paid was less than the cost it would have been to build it,’ he says.
All this tells me that there are plenty of deals for savvy real estate investors, and secondary market activity in mature markets will pick up in the coming years.

Speaking of savvy real estate investors, leave you with a couple of excellent interviews with Tom Barrack, chairman of Colony Capital LLC. In the first interview, Barrack spoke with Lisa Murphy on Bloomberg Television's "Street Smart" (December 2011). In the second interview, Barrack discussed his views on CNBC back in mid April.

Finally, ABC News reports that foreclosures have taken a sudden nosedive as bidding wars break out among US home buyers.