30 years, and two more crashes, on …

Citation

Baum, A. (2009), "30 years, and two more crashes, on …", Journal of Property Investment & Finance, Vol. 27 No. 4. https://doi.org/10.1108/jpif.2009.11227daa.001

30 years, and two more crashes, on …

Article Type: Editorial From: Journal of Property Investment & Finance, Volume 27, Issue 4

Thanks to growing investment in commercial property research, property investment has become better understood and better managed than it was since this journal was launched 30 years ago. Many of the problems that were associated with property investment at that time have found workable solutions. We can now say that the measurement, benchmarking, forecasting and quantitative management techniques applied to property investments are comparable with other asset classes. We were still learning in 1990, when the second property crash in living memory hit; but, unfortunately, the techniques we developed and fine-tuned beyond 1990 were not enough to prevent another crash.

By 2007, inevitably, clear overpricing had become evident in housing and in commercial property of all types in the UK, US and elsewhere. The ability of property investors and homeowners to take on debt secured on the value of property, coupled with the ability of lenders to securitise and sell those loans, created a wave of capital flows into the asset class and a pricing bubble. Professional responsibility took a back seat to the profit motive. Researchers became fund managers, academics became increasingly detached from the product development engine room, and boardrooms lacked the detached yet experienced voice that advances in information and research should have made available.

London and New York had become the main centres for creative property structuring through REITs, unlisted funds, property derivatives and mortgage-backed securities, and became the eye of the financial storm that followed. The technical advances made in information and research, and the spreading of risk made possible by the development of property investment products, did not prevent a global crisis from being incubated in the world of property investing. Worse, the global financial crisis of 2008 had its very roots in property speculation, facilitated by the packaging and repackaging of equity, debt and risk.

In the UK, a veritable laboratory for real estate research, 2006 marked the end of the bull market in property. The third consecutive year of returns in excess of 18 per cent, driven again by yields falling, presaged the bursting of a bubble that popped in the summer of 2007.

The main driver was clearly debt finance. Interest rates were low, and debt availability was unprecedented thanks to debt re-packaging and re-circulation. Data describing outstanding bank lending to real estate makes shocking reading for government and regulators. The coincidence of spikes in lending and a following crash is not accidental: 1989 and 2007-2008 are worryingly similar, but 2007-2008 is much worse.

The UK REIT market had begun to trade at discounts to net asset value in January 2007 and moved consistently downwards for that point until in January 2009 discounts were at an all time high, approaching 50 per cent (this may indicate implied falls in values yet to come, or a valuation lag, or both). Derivative prices for a three-year swap fell below LIBOR for the first time in April 2007, and below the required return on property even earlier, in January. Even unlisted shopping centre funds began to trade at discounts in December 2006, although the rest of the sector did not respond until the summer of 2007. These were all signs of a correction to follow in the direct market.

From January 2007 to June 2007, the IPD monthly index had been showing positive capital growth of between 0.27 and 0.46 per cent for each of the six months of the first half of the year. But by the summer of 2007 a change in market sentiment had happened, evidenced by fund managers warning clients of a poor outlook. This was reflected to some extent in the IPD monthly index, which produced its last positive total return of the cycle in July, disguising a tiny fall in capital value of 0.22 per cent, followed by a negative capital return in August of 0.4 per cent. The IPD monthly index took a downward turn of over 1.5 per cent in September. By October market sentiment had weakened again, the UK REIT market had moved to large discounts to NAV, touching 20 per cent in September 2007, and a year end effect began to gather pace as valuers took 8 per cent (£15 billion) off values in November and December.

The market at the beginning of 2008 was damaged by the gradual realisation of a global capital shortage (the credit crisis) which led to the eventual collapse of Bear Stearns in April and Lehman Brothers in September. This was expressed though a sharp increase in property yields. The yield series now clearly appeared to be mean reverting.

The unprecedented sharp yield increase, driven initially by the capital crisis, became further supported by a worsening prospect for rents, with financial services and retailing looking very weak as unemployment rose, consumer spending fell and recession beckoned. Many big names in retailing, including Woolworths, ceased to trade from the UK high street. It became clear in early 2009 that the UK had entered recession in July 2008, and it was expected to be long and deep.

December 2008 showed the largest fall in capital values in the history of the IPD Monthly Index, quarter 4 2008 the worst ever quarter, and 2008 the worst year in the history of the IPD annual series dating from 1971. In 2008, values fell by 27 per cent, wiping £46 billion from the value of the IPD universe worth £172 billion at the beginning of the year. Yet UK property shares were, by the end of 2008, trading at the biggest discount to NAV ever seen in recorded history, and indicating an expectation of more trouble to come.

Derivative margins and consensus forecasts appeared to suggest that expected falls in capital values from the peak in 2007 to a trough in 2010 were somewhere between 45 per cent and 55 per cent. This is unprecedented in any developed market, ever.

So what now for international property investment? Will the crash of 2007-2009 mark the end of an era of creativity and submerging barriers? Will globalisation and securitisation of real estate go into permanent reverse? Is the asset class a worthy component of a mixed asset portfolio? The agenda has been written, and the challenge issued.

Acknowledgements

The issues dealt with in this Editorial are the subject of Andrew Baum’s new book, Commercial Real Estate: A Strategic Approach, published by Estates Gazette in May 2009.

Andrew BaumHenley Business School, University of Reading, UK