(First of three parts)
It is clear that in the years leading up to the crisis, real-estate values became significantly detached from fundamentals, leading to asset bubbles in many markets. Values became far more sensitive to capital flows than to the underlying operating performance of the assets. The core characteristics of real estate, such as a reliable income stream and close correlation to GDP, were eclipsed in the majority of developed economies by speculation on liquidity and leverage-fueled repricing of the asset class.
The legacy of the crisis continues to impact on the industry; its effects are likely to be felt for some time given the lack of an imminent solution for plugging the debt liquidity shortfall in Europe and North America. One direct consequence is that institutional investors have become increasingly risk-averse, refocusing on underlying asset-fundamentals, and perhaps becoming more sophisticated in their consideration of volatility, risk and return. This topic has featured on the agenda of nearly every industry event in the second half of 2010, and remains high on the agenda of chief information officers across the industry.
Some forward-thinking research departments are already well-advanced in defining new approaches to assessing real-estate risk, return and portfolio volatility. We expect that communication between fund managers and investors will increasingly include this type of information. Funds adopting investment strategies and performance reporting based on this may well be the winners in attracting new investment into the sector.
Real estate needs to compete effectively with both the mainstream asset classes of equities and bonds, as well as with the alternatives such as private equity, hedge funds and infrastructure. Those more experienced investors are demanding far greater disclosure of the risks faced from the markets within which the underlying assets operate, through to specific property risks and the portfolio mitigating effect.
At one level, the challenge is one of communication. Fund managers need to learn to communicate using familiar investment language and terms, rather than the real-estate language of “core,” “core plus,” “yields,” “ERVs,” etc. In short, investors want to understand, for a real-estate portfolio, the expected return range and its risk profile.
(To be continued)
