“Is this the beginning of the end or the end of the beginning for the current cycle?”
That was the question we posed at our recent Four Quadrants event. Our panellists debating the question came from a range of backgrounds, including listed markets, real estate debt, private equity and physical real estate.
As you might expect, there were convincing arguments for both sides. For those who believed this was the beginning of the end, key factors included:
• The US economic cycle is close to peaking, which will affect the rest of the world
• UK yields are at, or near, their 2007 cyclical lows and UK rents are at, or above, their 2007 highs
• The volume of debt in UK transactions grew by 57% last year, and is following the same trajectory in nominal terms as 2003-2005
• The impact of global events such as the slowdown in China.
However, the “end of the beginning” rationale comprised:
• Real capital values have some way to recover
• Real rents are still close to long-term lows
• Yields are well supported by the wider capital environment
• Debt volumes are increasing, but the net debt outstanding to real estate is still falling and is considerably lower than previous peaks. The market is still equity-led
• While many focus solely on London when it comes to analysing rents, jobs, values and volumes, the rest of the UK and indeed Continental Europe is still a long way behind.
So which argument is more likely to be correct?
In short, maybe we are looking at things too simplistically. We constantly compare today’s market with the previous cycle, but there are in fact many different cycles currently in play, with different markets at very different stages and impacted by different events.
I do not believe, as I have said before in this column, that the UK real estate market has reached its peak. While the capital markets cycle appears advanced, economic recovery in the UK still has some way to go and will continue to support rental growth in certain areas. We are operating in a very different environment to the previous cycle, and most reassuringly we do appear to have learned from some of our mistakes.
The clients I speak to on a daily basis, those running real estate businesses, remain very much aware of what went wrong last time. Caution and sensibility are the tenet of most investors and, encouragingly, this thinking is not just limited to the world of real estate.
At his recent speech at the Property Investors Banquet, Alex Brazier of the Bank of England recognised the importance of the commercial real estate industry, saying: “When commercial real estate catches a cold, the whole economy starts to shiver.” Importantly, he added: “The cycle is a force of human nature, but resilience to it can be nurtured.”
The Bank of England is fully behind our industry and has put in place and continues to refine stringent measures, particularly with regard to lending against real estate. Resilience in the banking system is crucial, but having the data to monitor and potentially forecast problems ahead is just as important and, as outlined in the proposal of the cross-industry Vision for Real Estate Finance, a centralised loan database surely must be a prerequisite.
The key to the continued success of our sector is to nurture such resilience by behaving responsibly and sensibly. Of course, we need to keep a close watch on where we are in the cycle, but this is only part of the necessary discipline of continually updating our business strategies to appropriately reflect current market conditions. It is also imperative that we work closely with other bodies and organisations that affect the world of real estate to ensure our industry practices are as robust as possible.
If, as an industry, we can continue to do both these things, then I believe we should be able to better weather the next downturn – whenever it arrives.
Richard Dakin is managing director, CBRE Capital Advisors
