Viewpoint: Two-speed recovery will split the property world

Now is a good time to consider what 2011 holds for global property markets. We at DTZ predict that real estate market fundamentals will be driven by the exact path of the two-speed economic recovery. In contrast to most Asian and central and eastern European markets, slow eurozone GDP growth is expected to produce only modest rises in rents and capital values. In short, a two-speed economic recovery will translate into a two-speed property market recovery.

The latest data, including the preliminary -0.5% 2010 Q4 UK GDP growth, show that we are in a period of great economic uncertainty. Financial markets are uncertain about the effect of sovereign debt problems and proposed new regulation. In our view, such regulation will take a long time to be implemented and interpreted. Decisions to take advantage of attractive opportunities might be delayed until the impact of regulations is better understood, which could delay the overall recovery of the market in the short term.

Secondly, global investment managers with large compliance and regulatory staff are more likely to reduce the impact of regulations on their operations and profitability, while the administrative burden for start-ups could discourage the launch of new investment management platforms. In other words, the medium-term impact could be to limit competition. Despite a slow return to normality in funding markets, we expect central banks’ unwinding of special funding and hardening of monetary policy will also dampen lending and economic growth.

To address these uncertainties, we calculated the impact of positive and negative economic scenarios for six international office markets. Encouragingly, in the negative scenario of a 0.6% annual dip in global GDP, only Tokyo showed negative rental growth. Office rents are most sensitive in Tokyo, Hong Kong and Frankfurt; in Paris, the West End of London and Singapore, they are less sensitive to GDP, while New York offices are least sensitive.

Offsetting these uncertainties, a record $376bn of equity was available for property investment as of last October. Many investors are cautious due to legacy debt issues overhanging Western markets. In November 2010, we estimated there to be a $245bn global debt funding gap. But, as the economic recovery continues, we expect proactive equity investors to bridge this gap.

The evidence can already be seen in rising deal volumes. Global investment volumes hit $325bn in 2010, up 65% on 2009, mainly driven by China and the rest of Asia Pacific, where deal volumes nearly doubled in 2010 to $78bn and $145bn respectively. We forecast moderate capital value growth for most regions.

But the real issue in most Western markets is whether equity can effectively price and structure a profitable solution to the debt funding gap. We are encouraged by the wide range of solutions found by banks, existing and new equity investors, and government-sponsored work-out bodies. Many banks have moved on from a blanket ‘extend and pretend’ policy across portfolios to a customised ‘work-out, extend and amend’ approach.

Distressed asset sales have traditionally been a great opportunity for new investors, or newly capitalised investors, to generate excess returns. It is also key that Asia Pacific governments do not over-compensate in their restrictive policies as they attempt to control inflation and asset prices.

The other two-speed recovery is the way the rebound in capital values has been limited to prime properties, as secondary values have lagged behind. But despite our poor rental growth forecast for secondary UK property, we expect more investors to focus on secondary assets in 2011.

They will especially target near prime and value-added assets, due to an increasing lack of good opportunities in the already repriced prime sector. The result will be a further split between good and poor-quality secondary assets in the next few years. The importance of pro-active asset and property management will come to the fore, as it is essential to maintain stability of cash flow.

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