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Summary real estate management
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Summary Real Estate Management in the MSc Transport and Supply chain management
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Summary Real Estate ManagementBy Pepijn Paans
Student 2016 – 2017
MSc Transport & Supply Chain Management
FACEBOOK: https://www.facebook.com/pepijn.paans
LINKEDIN: https://www.linkedin.com/in/pepijn-paans-6b828a80
EMAIL: Pepijn_paans@live.nl
, Summary Real Estate Management
Chapter 1: Real Estate, the global asset
The value of investable stock of commercial property available to institutional investors
around the world has been estimated to be worth $16 trillion.
The largest market is the North Amerika 33% then Europe 32% and Asia 27%.
In the US: offices > apartments > retail > industrial > hotels by size.
In the UK: retail > offices > industrial
The largest investors in RE are pension funds, insurance companies and sovereign wealth
funds.
Pension funds have direct liabilities while wealth funds don’t and only have a broad
objective to protect the nation’s wealth.
RE suits investors without short-term liabilities better, because it is illiquid.
Institutional investors tend to hold less property than It’s natural market weighing because:
• Illiquidity and lumpiness
• Alternative new asset classes which offer same diversification as RE
• Lack of trust in property data
Because property is an actual physical asset, it deteriorates and suffers from obsolescence,
which together make it depreciate in value.
Lease contracts control the cash flow of a RE project. Rents are usually reviewed on a
periodic basis and are linked to e.g. the consumer price index, uplift at each review etc.
The supply side in RE is highly price inelastic, i.e. when prices increase supply increases
much less. If any, the supply response experiences lag due to obtaining permissions to build,
prepare a site etc.
The short-term returns delivered by property are likely to be heavily influenced by
appraisals rather than any marginal prices.
Property is highly illiquid. It is expensive to trade property, there is a large risk of abortive
expenditure, and the result can be a very wide bid-offer spread.
Trading is so expensive due to taxes paid on transactions, survey fees, valuation fees, legal
fees etc. This causes the bid-offer spread because sellers want to gain back their initial
buying fees with the new price they ask for the property.
Large lot sizes produce specific risk, because the high prices make it hard to diversify the
portfolio.
Property is heterogeneous: investments can do well when markets do badly.
Property is lumpy: large and uneven sizes of individual assets.
,Leverage is used in the majority of property transactions. This distorts the return and risk of
a property investment. Leverage (or gearing) is used to describe the level of a company’s
debt compared with its equity capital, usually expressed as a percentage.
60% gearing meaning that 60% of its equity level is debt. It could also mean the debt
compared with gross assets (debt plus equity)
gearing reduces the amount of equity that needs to be invested, it reduces the net cash flow
available to the investor by the amount of interest paid, and it reduces the net capital
received by the investor on sale of the asset by the amount of the loan still outstanding.
If the prospective return on IRR on the investment without using leverage is higher than the
interest rate charged then leverage will be return enhancing; and the greater the leverage,
the greater will be the return on equity invested.
Property appears to be an inflation hedge, because property rents closely correlate with
inflation in the long run, producing an income stream that looks like that produced by an
indexed bond.
Property is a medium-risk asset, rent is paid before dividends, and as a real asset property
will be a store of value even when it is vacant and produces no income. The return should
be expected to lie between those produced by bonds and equities.
Some findings say property is less volatile than bonds even, this does however disguises the
illiquidity of property. The current valuation can be unsmoothed, by using the formula:
Vt = aVt* + (1 – a)Vt-1
Where a is a smoothing factor. Vt is the current valuation and Vt* is the current market
value (which we can derive from the formula when we know the current valuation and last
year’s valuation.
This will give a higher volatility.
Real estate returns appear to be controlled by cycles, the main explanation being the very
inelastic property supply. Development activity appears to be highly pro-cyclical with GDP
growth and property values (rising and falling and the same time), but with sharper rises
and falls.
The time lag between the inception and completion of developments creates a supply cycle,
as a reaction on increasing development profits.
Rents have also been strongly pro-cyclical with GDP, when GDP rises rents rise, supply
follows and property will be developed, construction activity may peak during GDP peak and
oversupply results.
Property appears to be a diversifying asset, property returns have been less well correlated
with returns on equities and gilts than returns on equities and gilts have been correlated
with each other. So while gilts and equity usually perform well or badly at the same time,
property has outperformed or underperformed at different times, thus smoothing out
overall performance.
,Chapter 2: Global property markets and RE cycles
1970s USA: mortgage REITs fund excessive development > oil price increases rapidly and
inflation with it > interest rates increase and this makes it hard for developers and investors
of RE to keep up with loan payments > borrowers start defaulting and lenders foreclose
property > REIT market falls
1980s USA: new investors flood the RE capital market: Tax advantages were introduced >
and pension funds had to diversify their portfolio more > and international investors who
could borrow cheaply in their home country > and expanded availability of cheap debt, all
increased the market values of RE. This resulted in more supply of property.
Economy slid and tax advantages were changed so that property values fell. Loans matured
but couldn’t be fully paid back.
1990 – 2002: the rise of REITs
many financial institutions were left with property that was defaulted on because of a no-
recourse loan. Many institutions eventually went bankrupt and were taken over by the
government, that now had a large property portfolio.
It was decided to auction the portfolio of bad loans and property, properties were initially
sold at a fraction of their loan.
The commercial mortgage backed securities (CMBS) market also grew substantially as a
result of the liquidations, non-performing loans were pooled together and sold at discount,
leaving room to re-negotiate mortgages and give the borrower some air.
The REIT market also grew, growing from 8.7 billion in 1991 to 161 billion in 2002, mainly
due to the introduction of the Umbrella Partnership REIT (UPREIT). UPREITS allowed limited
partners in RE to turn their holdings into shares of publicly traded REITS. The benefit was
deferral (uitstel) of taxes and improved liquidity.
In the late 1990s investor psychology changed and focused on a desire for growth. Dot-com
companies sucked enormous amounts of capital from traditional industries. When the dot-
com bubble burst, RE was in over supply due to companies discontinuing business.
2002 – 2007: a rising tide lifts all boats. Home loan underwriting standards relaxed between
2002 and 2007, easy credit increased demand for property and home prices rose.
The same was true of commercial property markets and with this increased debt and equity,
capitalization rates (yields required by investors) dropped drastically to compete for
property.
Interest only loans increased as a percentage of all loans between 2002-7, increasing risk for
CMBS investors
Abundance of debt capital, expected benefits of positive leverage and the believe by most
RE industry that good times are to stay led investors to believe that their historical high
prices paid for property would be bailed out by ever-increasing values. This led to aggressive
assumptions and in the end to very high prices paid for property.
, 2007 – present: global real estate credit crisis:
poor underwriting resulted in defaults on residential mortgages
the RE market is a cyclical market, cap rates typically vary between 6% and 9%.
The UK property market – performance history:
In the 1980s and 1990s commercial property underperformed equities and performed in
line with low-risk government bonds.
Between 1980 and 2010 properties returned on average 11.6%, equities 16,2% and bonds
11%
1950 – 1973: from low inflation to a boom. Very low inflation caused RE to boom in the
1960s.
rent reviews were typically over 20 years or longer but this was changed to a five-year rent
review mid 1970s. property was no longer a fixed interest (fixed rate on borrowing)
investment.
1974 – 1981: A small cycle high inflation
oil prices rose and the barber boom in 1973 caused the property markets to crash, the
equity markets to crash, and the economy as a whole to crash.
Distressed properties were bought by insurance companies, and served as an inflation
hedge which proved important in this period.
1981 – 1989 high inflation, another boom
property companies were enabled to increase borrowings and financial gearing, and
property boomed again. However, interest rates rose, property rents fell and capital values
fell even more.
1990 – 1999 deep recession, low inflation and globalization
early 1990s rents tumbled, property companies failed and bank loans were non-performing,
all resulting in a loss of investor confidence.
Overseas purchase investments started flooding in, those foreigners were familiar with fixed
income, low-risk bond-like RE, at attractive yields.
The sterling devaluated (less $ for 1 sterling, i.e. more sterling for 1$), so larger buildings
could be purchased by an overseas investor for the same outlay in domestic currency terms.
mid 1990s rents rose again and yields shifted dramatically.
Returns between 12% and 15% each year in 1998 and 1999 against real price rises between
3% and 6% were realised.
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