The most common question I get asked as an investment agent is: What Are You Seeing In The Market? I try and answer this question here.
‘’We never know where we’re going, but we ought to know where we are.” Howard Marks
What Are You Seeing In The Market?
SVB, Credit Suisse and the Office Market – The era of cheap money is over and is playing its part in the chaos surrounding the banking world. Following the ‘08 crash, governments responded by pumping money into the economy leading to rising asset prices and in real estate’s case, sharpening of yields. This was intensified post-Covid, with governments pumping even more money, followed by an overheated economy and unsustainable levels of inflation. Central banks were left with little choice but to cool the economy down, raise interest rates and end the era of cheap money.
The current issue with the banks is that they hold large proportions of debt in commercial real estate, specifically offices. These loans were financed when interest rates were at record lows and now need to be re-financed at higher rates, lower values, and in a market with less liquidity. This is exacerbated by many fearing for the future of offices with the rise of WFH and increased vacancies. Whilst offices have historically been perceived to be the safest real estate asset class, many are reconsidering this and are worried about defaults.
To read/listen more about the current situation, here, here, and here.
Prime and High Yielding – Is demand still there for prime assets? Yes. But as with most assets, there needs to be a discount versus yesterday’s pricing. Over the past decade, borrowing costs were close to 0% and returns from holding cash in the bank were non-existent. Comparing this to returns of prime assets at 3-3.50%, investing in prime assets was appealing. Today, borrowing costs and bank returns are higher than prime assets trade at. For this reason, prices need to shift. At the right price, demand is there as investors consider prime assets to be long-term wealth preservation, have mandates to invest, as well as discounts versus long-term values.
Demand also remains for high-yielding assets where there is a yield cushion between real estate and bank rates or borrowing costs.
Foreign Money – Amidst the controversies surrounding the UK, it is still perceived to be a safe haven. It benefits from the English language, has a robust legal system, is stable (less so these days), and is a transparent market. The UK has recently been on the wrong side of the press, although things are settling down. Ties are being mended with the EU, whilst internal issues with its neighbouring countries suggest the UK is not the only country with troubles. This combined with a weak £GBP, the UK remains an attractive market.
EPC – From 1 April 2023, any property with an EPC of F or G will be illegal to let. Research suggests that millions of square feet will become illegal overnight. In reality, it is unlikely to happen, and inevitably some sort of deferral or loosened legislation will be put in place. Beyond April 2023, the push towards sustainability is heading in one direction and real estate will play its part.
[Update: no properties have become illegal overnight.]
Final Thoughts
What the future holds, depends on who you ask. Real estate reports suggest a recovery is around the corner. Twitter suggest WW3 lies ahead. The reality is that most people’s perceptions lie somewhere in the middle, although ultimately no one knows what’s next.
In a tough market, many investors take a “wait and see” approach. Investors that do buy, spot opportunities that many do not. For that, there needs to be an angle.
A couple of thoughts from the past month:
Twitter thread on real estate skills by StripMallGuy.
Dror Poleg with an informative article on the latest situation in Israel.
Highly recommend Chip Wars by Chriss Miller; gives great insight into the battle for semiconductors.