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When Will The Market Cool?

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When will the market cool?


What goes up must at some point come down. Or at the very least , stop goin g up. With property prices across the world hitting records by the month , it is not only industry doom-mongers who are mulling the implications. For now, most concerns have focused on residential property, but more professionals are speaking - privately or publicly - about commercial property. It is not that they are predicting a crash. But many fear that double-digit returns will be harder to achieve and that falls in prices are possible in over-exposed markets. The generic property boom is, to a great extent, one of the many co n sequences of the unprecedented liquidity in global financial markets. The cost of borrowing is so low - from Osaka to Nebraska - that investors can afford to buy real estate at ever higher prices. So the first danger for the market is interest rates. In the US a monetary po licy tightening is under way. In Europe, further rises are a possibility this year . In Japan, most experts expect a rise in interest rates from its current zero level. Cuts in rates are only considered likely in a few countries, such as the UK.

This could have ramifications for a global property investment industry based on the easy affordability of borrowed money. "The big danger is that if inflation starts to re-emerge, it will really have an impact on property investment by prompting further rises in inter est rates ," says David Brush , chief executive of property fund mana gement company Rreef, part of Deutsche Bank. Of course, property yields could fall below borrowing levels - as they did a decade ago. But in the 1970s and 1980 s , property was often bought , in spite of low yie lds, as a hedge against inflation, which is no longer so relevant. Alm ost everyo ne agrees that the comme rcial property market will cool down. The dis ag reement is more about timing: will it be this summer, autumn or winter? Will it be a year or five years from now? One thing is certain: At some point, there will surely be no more of the yield compression which has kept prices soaring as investors reappraise the merits of commercial property. The phenomenon has been described b y Stephen H ester , chief executive of British Land, as coinage that can only be spent once. Equally certain is that investors are making mistakes right now which they may live to regret. Rental growth could provide a panacea for the entire industry but it is not guaranteed in any particular sector. So: who is buying wisely and who is not? Many buyers have presumed that if they can cover their borrowings with rental income they are immune to danger. But Alastair Ross Goobey, former head of Hermes fund management, suggests that investors are facing purgatory postponed . He argues that many are ignoring the potential consequences to a property's value when tenants are near the end of their leases. Geral d Parkes, head of Lehman Brothers' European real estate private equity group, predicts a disappointing period of returns for property beyond the next year or two. He agrees with Mr Goobey about investors' attitude to risk. "I have been concerned for s ome time that people may not be pricing in residual risk properly. "When you have only five years left on a lease, how will people value that investment?" he warns. "[To be safe] you will need to have a more robust economy and a more robust occupier market." Mr Brush at Rreef believes that, on a regional basis, the US is the most over-pricedmarket. Rreef's new global fund (its third), with $4.5bn to spend, will allocate only 10 to 5 per cent to the US.

"The US market is the most expensi ve be c ause it has had such a long bull run and the wall of capital has been more prevalent there, valuations have starte d to look toppy, especially retail and urban offices," he says. Elsewhere Mr Brush singles out Shanghai flats as significantly overpriced. "It is like the dotcom bubble, people are comin g up with r at ional e t o supp ort prices with no economic fundamentals," he suggests. "Prices have been carried upwards by market momentum and will suffer if sentiment changes." Robin Goodchild, director of Euro pe an s tr at egy and research at LaSalle Investment Management, predicts a stand-off between buyers and sellers as global property prices carry on rising. He warns that the most over-heated sectors are secondary and tertiary property, where some investors have " indiscriminately " bought at similar yields to primary property. His tip for a fall in prices - albeit maybe a few years off - is Spain, which he says has "the potential to be the new Germany". He says: "There has been a tremendous demand for real estate in Spain at prices which may not be rational."

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Interesting. These are bearish HPC arguments now being aired in the mainstream financial press. Like an earthquake on the San Andreas fault, a HPC is easy to predict - except for the timing. If the arguments in this article begin to get more widespread credence, as they will if credit tightening continues, the day of the correction will draw nearer.

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It is mainstream articles in the influential newspapers that will affect the all-important sentiment. It seems most rational bulls (which includes all bears at this point in the cycle) accept that property inflation cannot continue indefinitely and that corrections are part of the normal course of events. Put simply, its correction time.

How many large commercial enterprises are investing in real estate these days?

Best advice is to follow the smart money.

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  • 312 Brexit, House prices and Summer 2020

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