The conventional wisdom about real estate is that it is a local business. Rents and market conditions vary from city to city (and between submarkets within cities), what's included in a lease may be different in San Diego from the norm in San Antonio, and investors have different expectations for properties in different places.
Maybe. But the 20,000 attendees who poured into Cannes in mid-March for the 17th annual MIPIM international real estate exposition seemed determined to prove that when it comes to commercial real estate investing, there is just one enormous hyper-marché. “The globalization of the investment market is here,” says Tony Horell, CEO of Jones Lang LaSalle's international capital group. “Global investors are competing with local investors.”
In 2005, according to Jones Lang LaSalle, a stunning $475 billion poured into commercial real estate investments around the world, a 21% jump from 2004. And that figure will almost certainly be surpassed in 2006, as investors scour the globe in search of yield. “Last year, for every dollar of completed transactions, there were two dollars chasing the deals,” says Horell. “This year there are three dollars.”
A recurring theme at MIPIM was the staggering amount of money that is being pushed into commercial real estate around the globe — and the escalation of values in anything resembling a stable market. Cap rates have been compressed in the U.S., the U.K. and most of Europe and many parts of developed Asia, leaving investors “looking further and further from home base for returns,” says Paul Richards, head of European capital markets research at JLL. That means pushing further into Eastern Europe, beyond Poland and Hungary and the Czech Republic, where a decade of commercial redevelopment has flattened cap rates.
Now, the action is shifting to places like Bulgaria, where developers say it's time to pounce before the nation enters the European Union in 2007 and prices rise. Another much-hyped destination is Turkey, whose entry into the EU is still being negotiated. “Turkey is wide open,” says Tim Stketchley, managing partner of Cushman & Wakefield's capital market group in London. “In 2020 there will be one global mega city in Europe — Istanbul.”
Where is all the money coming from? According to the experts at Cannes, the dynamics that have been driving more capital into real estate assets in the U.S. are at work across the globe. With returns in equity markets modest, institutional investors everywhere are upping allocations to real estate. And, even in places like Germany, where cap rates are evaporating, there is still an attractive interest-rate spread in commercial real estate investing. Finally, and most significantly for the long-term, there are hundreds of millions of aging citizens in North America, developed Asia, and Europe who are looking for the steady returns that they (or their employers or governments) believe can be achieved by owning commercial real estate.
“There is no end in sight to the weight of money coming into commercial real estate capital markets,” says Kelly Whitman, head of European research services for Property & Portfolio Research, who co-presented on a panel called “Extreme Demographics.” Forecasting trends through 2050, Whitman added, “Aging populations are spurring real estate investment — by pension funds and individuals — as the need switches from growth to income.”
While the major industrial economies continue to attract the most investment (88% of the $164 billion in cross-border deals were in North America and Europe), it's increasingly clear that the flow of funds will start moving from west to east — attracted by the fastest growing economies, China and India.
“The story in 2005 was the flow of institutional dollars from the United States into Europe,” JLL's Richards says. In the next few years, he says, JLL sees the greatest opportunities in Southeast Asia, a recovering Japan and in coastal China. In the medium term (four years out), the firm favors the so-called BRIC countries (Brazil, Russia, India and China) as well as Mexico, Turkey, Romania, Bulgaria and Russia. Long-term bets are on inland China and South America, he says.
While Russia and former Soviet republics were everywhere at MIPIM, including in a special tent strategically positioned between the registration tent and the Palais des Festivals, the biggest topics of discussion were China and India. (In her presentation, Whitman warned of long-term issues for Russia and Eastern Europe, where she cited projections of a 25% drop in population by 2050).
China is a particularly attractive long-term target because of its economic growth and demographics. China's gross domestic product is predicted to become the world's largest, at $4.5 trillion annually in 2050, with the U.S. in second place at $3.5 trillion, followed by India at $2.75 trillion, according to David C. Watt, executive director of DTZ International Property Advisors in Hong Kong. Meanwhile, upwards of 500 million inland Chinese will be urbanized, a process that could dwarf the development in coastal boomtowns such as Shanghai and Guangzhou.
For now, however, obstacles stand in the way of real estate investment in China, even for domestic investors. There is no REIT industry and banks are not permitted to lend on commercial real estate. In addition, the insurance industry, which is in its infancy, has just been allowed to make direct investments in real estate.
That's not to say that there isn't a lot of activity and speculation. Indeed, says Michael-Florian Ranft of Taylor Wessing, a German law firm, yields have already fallen on commercial properties into traditional Western ranges — 5% to 6% on office and 7.5% to 8% on retail. “You don't come for the yield, you come for capital growth,” says Guy Hollis, head of JLL's International Capital Group, Asia.
China watchers at MIPIM, however, say they expect an investment market to develop as liberalization in financial services spreads to the real estate sector and China's financial industry becomes increasingly integrated with those in the West. “Today, there are no real estate capital markets in China,” says K.S. (Sonny) Kalsi, managing director for Morgan Stanley Japan Ltd. “But eventually there will be CMBS and investment equity capital vehicles.”
Kalsi is looking at a recovering Japan as a solid near-term play. He acknowledges that the Japanese economic recovery has been predicted for many years, but he points out that in 2005, for the first time since Japanese property markets crashed in the 1990s, land prices rose in Tokyo. In addition, he says, the Japanese REIT industry is off to a solid start. “Eight years ago there was not CMBS, no REIT business in Japan,” he points out. Now, he says, the total market cap of Japanese REITs is around ¥4 trillion, and he predicts that number will double in the next 18 months as new issues come to market and values appreciate, accounting for perhaps 20% of the increase. Japan has $2 trillion worth of commercial real estate, including 840 million sq. ft. of office space in Tokyo — close to 2.5 times the inventory in New York. Much of that stock is 40 or 50 years old and ripe for redevelopment.
Japan isn't the only area where massive redevelopment is predicted. Indeed, developers at MIPIM were not only trying to lure investors into exotic new locales, but also into redevelopment projects in major markets across Europe and North America. A major theme was sustainability — creating new, environmentally friendly and efficient commercial buildings. Europe is way ahead of the U.S. in creating and/or retrofitting buildings to green standards, says Paul A. Laudicina of A.T. Kearney, but he predicts that the proportion of green buildings will jump from about 3% of commercial buildings now to 10% by 2010.
With all the global money pouring into commercial real estate, is there danger of a global bubble? Richards of JLL maintains that pricing is “rational” at the moment — despite sub-5% yields in some sectors — because interest rates have not risen as much as had been feared going into 2005. He says there is a debate within the firm as to whether cap rates will bottom out late this year or in 2007. The bottom line, he adds, is that you'll see more money going to exotic places. “There is still a lot of room in less-developed, riskier markets in the developing world,” he notes.
Geoff Lewis is the editorial director of NREI