Shocks, windfalls in global commercial property investment
The $11 trillion US commercial property market was the ultimate beneficiary of the post Lehman central bank money printing era and China’s $4 trillion dollar reserves war chest. No longer. The Yellen Fed is set to raise the cost of borrowed money for the next two years.
The 2004-6 interest rate tightening cycle saw 19 successive FOMC rate hikes and a 375 basis point rise in the Fed Funds rate. This cycle will be no different as Trump’s policies boost inflation risk and the post-election bloodbath in the world bond market ($3 trillion in losses!) continues. The eight year bull market, which has seen the prices of office buildings in prime markets (Manhattan, Boston, San Fran etc.) double, will end with a vengeance as interest rates and inflation surge in 2017-18. Vacancy rates have begun to creep higher. Sales growth trends have softened. Default rates on commercial property backed pools (CMBS) are up at least 10 per cent in the past year.
At least $250 billion of commercial mortgage backed securities principal comes due in 2017-18, the legacy of credit bubble era loans in 2006-07. This is a double whammy for landlords and lenders, many of whom are handcuffed by Dodd Frank risk retention rules. I prefer investing in short duration, floating rate bank loans to this illiquid, overvalued asset class.
I was alarmed to read that 24 per cent of London commercial property buyers are now from the GCC, up from 10 per cent in the pre-Brexit era. GCC investors have been lured by the optical illusion of a cheap sterling and the protracted property bear markets in the Gulf. This is a strategic mistake. Chinese
at least $250 billion of commercial mortgagebacked securities principal comes due in 2017-18, the legacy of credit bubble era loans in 2006-07
money will no longer lift values in prime London as Beijing cracks down on capital flight from Middle Kingdom. Sterling is a classic value trap as it can well decline to o1.05 on cable by end 2017. London commercial property (mainly the City of London) face an epic shock from the exodus of bankers to Dublin, Berlin and Paris. London home prices are almost comically overvalued. Watch the Nine Elms/Battersea condos, sold off plan by dodgy brokers in hotel lobbies in the GCC and Hong Kong, lose 50–70 per cent of their value as investors default en masse on their “commitments”. Better luck in the Karama Hills luxury villa project. I see GCC investment banks peddling London commercial property funds as a bargain Poppycock. Once again, Gulf investors are being set up as the patsy as the music stops.
The real money making opportunity in commercial real estate lies in markets where supply is limited, demand is inelastic and government policies are hugely pro-higher property prices. This is the reason our Makkah four-star property portfolio generates 18 per cent annual cash on cash US dollar net returns on 20 year fixed rate leases. This is what I call an alpha gusher with a 1400 year inelastic demand track record! Other niche opportunities that provide 10–12 per cent annual returns are undervalued office buildings in Warsaw. Note that Poland is attracting hedge fund smart money, the Polish equities index fund (symbol EPOL) is up 17 per cent in 2017 (no typo. 17 per cent, year-to-date!) and I finally plan to visit the homeland of Frederic Chopin and Marie Curie this summer.
Demographics also creates asymmetric investment potential, as do disruptive technologies (Ecommerce), sunrise industries (DIFC in Dubai? Biotech in Cambridge UK?) and the age old human migration from villages to urban concrete jungles.
I have visited the startup ecosystems in San Francisco and Silicon Valley but also in Berlin, the Silicon Glens and Mumbai’s Marine Drive. Retail space will be sliced, diced, released, reconfigured and derated by the digital revolution and the ecommerce juggernaut. The shopping mall, sadly, is headed down the path of black and white TV, horse and buggy carriages and brontosaurus.
Online leasing and data analysis technologies will slash brokerage costs. I do my own onsite research for my Saudi and UAE investors, roam the world to originate opportunistic real estate deals from Marbella to Makkah. Investors who cannot grasp the complex fluid global macro dimension of property can and often do get wiped out in this leveraged asset class.
Office space usage will be revolutionised by the millennial generation’s work-play choices in Silicon Valley now and in the GCC in the near future. The next big thing will be “industry clusters” located near talent hubs. Sharjah could well take advantage of this trends, thanks to its Boston like proliferation of universities and colleges. Department stores will be redeveloped as ecommerce fulfilment centres. Watch Macy’s move!