"It was the best of times, it was the worst of times"
(Charles Dickens, A Tale of Two Cities, 1859)
The last 20 years of the 20th Century will go down as a period when the international real estate market achieved two things: maturity and global spread. Like a wayward teenager, real estate learned from its mistakes, went to college and became better educated and then demonstrated more prudence and caution than previously. At the same time, with international commerce, trade liberalization, and globalized capital came a passport and escalating air miles.
In the early years of the new century, real estate, on a risk-adjusted basis, looks like a preferred investment asset class throughout much of the world. Cycles come and go, but supply and demand are, for the most part, relatively well balanced in historic terms in most countries. Prices are shifting incrementally rather than dramatically and the volume and profile of capital and debt entering the sector is far better regulated and subject to far more due diligence than before. With an aging global demographic and volatility in other asset classes, real estate has become a target for both venture capital and annuity, bond-style investors seeking retirement profile income. "How are we going to fund our retirement?" is Item One on the sociopolitical agenda in the Western world with real estate right there alongside in the action column. Expectations are high.
By way of illustration, the Australian Government has introduced compulsory pension contributions for all employees in defense against a poverty-stricken retired population in the medium to long term. The net inflow of capital into Australian superannuation (pension) funds has increased at an unprecedented rate in consequence and, by volume, is set to overtake the value of the nation's entire fixed asset base. Asset and geographical diversification are now not only a certainty but mission-critical from a risk perspective. Real estate will figure prominently as a result of its ability to offer stabilized, annuity style returns over time, thereby matching policy liabilities against capital and fund liquidity requirements. It is only a matter of time before the other developed nations of the world follow the same route. Global capital flows in real estate will escalate dramatically in the next 20 years. The public and private REITS in the United States currently represent dramatically different options for investors and yet both have thrived in recent years with high expectation for both.
Capital alone however, does not a market make. The intensity with which qualifying investment opportunities are being bid up by investors anxious to place capital or take advantage of a cost of finance to income arbitrage environment that has not been seen in more than a generation, means that cap rates are being driven down while the underlying demand for the commodity, in this case real estate, is weakening. This is an imperfect market in any textbook. There is perhaps still more maturity required for this very new market type predicament, which has created a fundamental disconnect in many real estate markets around the world.
The stakes are high. The combined value of the developed economies' residential and commercial property markets is greater than the combined value of all the international equity and bond markets added together. In many countries, imperfections in the real estate sector are actually directly impacting upon that country's largest fixed asset base. Real estate really is big business. Indeed, its fixed capital position and its investment expectation profile arguably make it the biggest business of all moving forward. It is also worth noting that around 30% of the developed world's commercial real estate by value (some $4.7 trillion) is located in the United States.
So, what of demand? The equity markets are inching back upwards on the back of gradually improving …