Increasing liquidity drives investment volumes
Global direct commercial real estate investment totalled just over US$94 billion in Q1 2011, which is up 44% from the US$65.6 billion total in Q1 2010. The quarterly sum puts the market well on its way to exceeding our preliminary full-year 2011 forecast of US$380 - 400 billion. We now expect volumes to be above US$440 billion, up 35-40% on 2010 and the highest volume since 2007.
All three regions are growing year-on-year, with the Americas leading at +125% (but from a low base), followed by EMEA at +29% and Asia-Pacific at +14%. There were 17 billion-dollar country investment markets in Q1 2011, among which the most active were the US (US$22.9 billion), the UK (US$13.6 billion), Japan (US$9.0 billion) and Germany (US$7.3 billion). The fastest growing large market is Brazil which, at US$6.7 billion, again posted a record quarterly volume. In Q1, Brazil became the fifth most active investment market, overtaking China - an impressive growth trend given, that as recently as 2008, the country ranked thirtieth globally.
Investors selectively moving up the risk curve
Equity investors continue to target low-risk assets in prime locations, but are becoming increasingly frustrated by pricing and lack of suitable product. A number of investors are signalling a move up the risk curve, widening their geographical horizons and the types of assets they are prepared to consider. The move into ‘riskier’ style transactions includes smaller assets, shorter income, some voids and development opportunities. However, most investors are not prepared to compromise on quality and continue to show caution with regards to secondary assets. As investors move up the risk curve, their preference is for prime assets in ‘secondary’ cities, rather than secondary assets in main cities.
Yield play is largely over
In response to intense investor competition for prime assets in the world’s top-tier office markets, capital values have continued to appreciate strongly. Across 22 major office markets, capital values at Q1 had increased by an average annual rate of 22%, with some markets registering 40-50% growth over the previous 12 months. However, the strong yield compression, which has been a feature of the market as a whole since mid-2009 and has resulted in prime yields in several markets nearing the levels of the previous cycle’s peak in 2007, has largely disappeared. Prime yields were broadly stable in Q1. Further capital appreciation in 2011 will be driven by rental growth more than yield shift.
Asia Pacific volumes continue to grow
In Asia Pacific, investment volumes in Q1 2011, at US$27 billion, have risen in comparison to both Q1 and Q4 2010. This continued growth is testament to the strong fundamentals in the region. Domestic investors are dominating activity – all buyers in the top 10 deals in Asia Pacific were Asian, while sellers were 60% Asian and 40% Global, European or American funds. Investors are acquiring more properties en bloc as well as portfolio assets, with the biggest portfolio deals being mainly for retail properties.
Japan has been the most active real estate market in the region, with a confident start to the year boosted by strong acquisition activity by J-REITs and private equity funds, albeit prior to the earthquake. We anticipate some impact on Q2 volumes as a direct consequence of the disaster. Even though some deals may be delayed in the short term, most established investors continue to be confident in the Japanese market and see potential buying opportunities.
There were also notable slowdowns in the region in Q1. Volumes in China declined - a likely response to regulatory tightening and rapid capital value appreciation. Australia also saw a drop due to shortages of high-quality prime grade assets. Nonetheless, the market remains very strong, yields are compressing and a significant wall of money is targeting Australian real estate. There is strong interest from foreign investors and also from Australian funds who are repatriating money from overseas and (in many cases) repositioning their domestic portfolios; moves supported by continued systemic growth in the volume of superannuation funds under management.
Activity picking up in Continental Europe
Investment volumes traded in EMEA in Q1 2011 totalled €26.2 billion (US$35.8 billion). This represents a 32% improvement (in euro terms) on a year ago, but the numbers underplay the level of activity, with deals in the pipeline suggesting an even stronger Q2 and Q3 2011. The UK was once again the most successful market at capturing capital, with the focus being on London offices, where overseas equity is competing for low-risk opportunities, long-dated income, prime locations and trophy assets.
Germany was the second most active market, with volumes totalling more than €5 billion (US$7.3 billion), 21% of overall regional activity. The dominance of the UK and Germany highlights the continuing investor preference for core prime assets, but investors are extending their geographic search.
The CEE region is featuring more prominently in investor discussions due to strengthening fundamentals and returns’ potential. In contrast, the ongoing Eurozone sovereign debt crisis is dampening activity on the Iberian Peninsula, with Spain and Portugal recording significant year-on-year falls in volumes. For most cross-border investors the risks in these markets remain too high, though there are a number of active domestic opportunistic funds seeking core assets.
Retail in strong demand in Europe
A number of large retail transactions, including the sale of The Trafford Centre in the UK and the Metro portfolio in Germany, are indicative of the strength of investor demand for retail assets. The sector accounted for 44% of activity across EMEA in Q1. Investor focus is on the ‘big three’ – UK, Germany and France. However, demand is beginning to ripple out towards a broader range of European capitals and major cities, and is concentrated on dominant assets with robust income profiles. Poland is at the forefront and is already considered by many to be ‘core Europe’.
US gaining traction
The recovery in investment sales in the US continues to gain traction. Volumes totalled US$23 billion in Q1, doubling the level of a year ago. Many property owners have been further heartened by the progressive improvement in market liquidity. Demand for higher-quality product is exceeding supply, pushing prime yields in several markets down to levels near the peak of the market in 2007. Furthermore, the volume of transactions reported to be ‘under contract’ continues to increase and at the beginning of April reached a new high for this recovery, which bodes well for a strong 2011. Investor interest is also moving beyond the main gateway cities into markets such as Houston, Dallas, Seattle and Atlanta. The multifamily sector continues to witness very healthy investor demand as robust market fundamentals and the availability of finance (including for new development) focus investor attention on this product type.
Improving debt situation in US
A key to the rapid recovery of the US investment market is the remarkable turnaround in the lending environment. From nearly every major debt capital segment there are more increasingly active participants, and the competitiveness among lenders for a healthy swathe of the market has intensified markedly over the last few quarters. Even the conduit lending market for securitisation has finally re-emerged to a point where it can once again be considered a significant component of the market. Through to April 2011, nearly US$9 billion in CMBS was issued, far exceeding the nominal amount issued in the same period a year earlier, and already more than three-quarters of the total issuance recorded for the whole of 2010. Current estimates for 2011 issuance range between US$40-60 billion.
Cautious optimism in Europe
The European real estate debt market continues to be subject to restrictions through regulation, liquidity and capacity. Banks remain concerned about the impact of impending Basel III regulations, which are likely to require banks to reserve further capital for real estate loans. Conversely, new Solvency II regulations mean that insurance companies are actively seeking to increase their allocation to real estate lending.
European banks are still working through the extensive legacy of pre-financial crisis problem loans. Until they are able to successfully dispose of, or refinance their wide-ranging exposure, then lending will be fundamentally restricted. This applies especially to loans secured against secondary assets. It is likely that there will be only extremely limited finance available for secondary assets in the near to medium term. In key centres and sectors, notably prime CBD offices and prime shopping centres, banks remain keen to lend and, as such, there is significant competition in this area.
Europe's CMBS is tentatively reopening with a major single asset deal in the UK. It is reported that a new mortgage bond will be secured on a loan from Deutsche Bank to fund Blackstone’s £480 million (US$770 million) purchase of Chiswick Park, a business park in west London. The deal's success will be closely watched by the real estate industry.
More choice in Asia Pacific
In the Asia Pacific debt markets there will continue to be much more choice in financing options and a greater selection of parties from whom to obtain debt. LTV ratios are now around the 60 to 65% range. The cost of currency hedging will be a major factor in the decision making of Asia Pacific investors in 2011 with currency risk a key consideration in the geographical allocation of capital.