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Introduction
Real estate has become a global asset class only relatively recently. The development of the industry is described elsewhere but the global element began to emerge from 1980 when Middle Eastern and Japanese institutions started investing in UK and US property; this accelerated during the 1990s with the arrival of the German open-ended funds followed by principally US investment managers offering closed-end funds for investment around the world.1 These investors needed to learn how to navigate their way around different real estate markets. While some aspects may have appeared familiar, for example, the same international banks and accountants occupying major central business district offices in different financial centres, alien legal systems and different market practices presented new challenges. This chapter provides an overview of the challenges that real estate investors face when they move outside the domestic market within which their knowledge and experience has been learnt. In particular, the analysis seeks to distinguish between the learning that can be applied without adjustment, because markets do work similarly, and the elements that an investor should expect to be different. Predictably, there is much more focus on the latter.
Over the first two decades of the twenty-first century, global real estate investing has become more common place. While, inevitably, strategies that reflect a domestic bias remain a material force, a number of factors have enabled cross-border or global strategies to become a much more viable part of the investing landscape. In particular, a key driver has been the ārevolutionā in the availability and quality of the information necessary to support cross-border investment decision making. This revolution has taken place at a number of levels from the increasing availability of consistent performance data for a wide variety of property sectors and markets through the activities of organisations such as Investment Property Databank (IPD), now MSCI, to better overall market information on a wider set of locations as a result of the emergence of global delivery platforms in real estate services (DāArcy, 2009). A key impact of this revolution has been a significant reduction in the importance of information costs as a barrier to international investing. A further factor worth noting has been the changes brought about in the structure of investment markets as a result of the evolution of the āindirectā market, both listed and especially non-listed. The expansion of the latter has favoured the creation of cross-border and even global non-listed property investment vehicles. As a practical illustration of such trends, over 50% of City of London office stock was in foreign ownership in 2011 (Lizieri et al., 2011) and that proportion has increased further since then, with the arrival of Chinese and other Asian institutions.
The danger is that investors and professionals forget that real estate is accessed through local markets with their own unique characteristics. An example of this danger is well illustrated by a subtle case study (Bao and Feng, 2014). Students are provided with data on 600 land transactions between 2004 and 2011 around Beijing and asked to advise a European investor contemplating investing speculatively in development land. The temptation is for all the effort to go into analysing the 600 transactions to discern price trends. However, the best students would recognise that the land parcels actually may not be tradeable, without first carrying out any development, because the ownership rights could be cancelled by the municipal authorities without compensation to discourage speculative āflippingā of undeveloped sites, particularly by foreigners.2
The classic texts in real estate economics all stress that the market deals in property rights and those rights have unique elements (see, for example, Ely and Wehrwein, 1940 or Turvey, 1957). The first task of a valuer or appraiser when instructed to value an asset is to establish, as precisely as possible, the property rights held by its owner, both their spatial extent and the legal rights attached to that space. This truism cannot be assumed away with the move to global real estate. Moreover, the nature of those property rights materially influences the rules of the market; effective players have to understand these rules. Investors and property professionals, therefore, need to establish how these rules are likely to affect their objectives in each new location into which they enter.
It is not practicable to provide a guide to the operation of every real estate market globally in a single chapter. Instead, this chapter provides a framework for understanding how individual market rules impact on the operation of markets and thereby either facilitate or constrain the objectives of specific market players. The chapter includes examples focussing principally on factors that affect investment returns, either directly by affecting cash flows or indirectly through their impact on market dynamics.
A simple market model
Real estate markets are driven by three broad interacting forces:
ā¢economic drivers ā local, national and global;
ā¢capital markets; and
ā¢new supply operating through local institutional frameworks.
The state of an economy, which itself is a function of local, national and global forces working in combination, is the principal determinant of the local demand for space from firms and households in any given market. The capital markets determine the level of interest rates, sentiment towards real estate as an investment relative to other options (such as stocks) and the general market level of risk aversion/tolerance, often described as the balance between āgreedā and āfearā, that influences the risk premium. As a result, capital markets have a major influence on investment flows to real estate and levels of liquidity. When flows are increasing, property yields tend to compress as prices are bid up and liquidity levels normally increase as more owners choose to capture profits. When flows dry up, vendors need to be prepared to reduce their asking price to attract bids. Moreover, capital market sentiment can change very quickly, causing yields to move sharply, so they are a major influence on the whole real estate market.
New supply is normally one of the most predictable elements of a real estate market because the construction process takes time, so accurate estimates can be made of, for example, new office supply for the next 18ā24 months. Forecasts are also made for longer time periods but these are usually less reliable because new projects can be added to the pipeline or expected projects delayed. Within the 18ā24 month period, construction work will have actually commenced, so the likelihood of projects not proceeding to completion is much reduced. Thus, real estate service providers publish ācrane surveysā for specific markets that highlight where new projects are underway and the overall scale of the pipeline.
This simple model is shown graphically in Figure 2.1. The model is universal and can be applied to any real estate market. Occupier demand for real estate is always a function of economic forces ā whether local, national or global; thus, gross domestic product (GDP) is invariably a material independent variable in any econometric model that forecasts commercial property rents and capital values. Capital markets, in any location, are always liable to sudden changes so are a major source of volatility in capital flows and liquidity. The relative importance of key capital market actors among banks, insurance companies, pension funds, high net worth individuals, mass retail funds, endowments and sovereign wealth funds can and does vary from market to market, so investors need to identify the key players that are likely to have the biggest influence in any specific market. In Germany, for example, the high net worth and mass retail funds play a more important role than the local pension funds, while in Asia, public market entities, both real estate investment trusts (REITs) and listed property companies, are a much more significant force than their counterparts in Europe. Notwithstanding this variation, investors should always be wary of the capital marketās ability to affect levels of liquidity, whether by design through, for example, a central bank changing interest rates or more randomly when sentiment changes as a result of an economic or other shock.
While new supply is always predictable because development is unavoidably time consuming, so that the pipeline can be identified, the way in which that supply is created and how the finished space is offered to occupiers is determined by a set of local rules and practices specific to each market. Thus, the institutional framework within which a property market operates is local and profo...
