The Opportunity Report

The Monster stalking EXPO Real

Just like mipim, sentiment at expo real provides a bellweather for the European property industry. In 2008 as the banking industry wobbled on its foundations exposing the true indebtedness of real estate, the mood was characterised by nervous laughter as even the safest of bets began to look uncertain. 2009 and 2010, by contrast were full of purpose as the industry began to put the worst behind them and drive projects forward.

Expo in 2011 had been moved back a day to accommodate the unification day bank holiday which, in turn, extended the Oktoberfest by a day. Staying close to the Theresienwiese fairground, it seemed sensible enough to visit the festival on the Monday and then go to Expo Real from Tuesday onwards.

Oktoberfest is a family event and, although there is a great deal of beer drinking, the event feels safe and comfortable with traditional dress  worn by many of the largely happy participants. But, like any fairground, there are rides aplenty, including the one known as the Monster.

The Monster is an enormous vertical pendulum with seats at one end. As the pendulum swings, back and forth initially then round and round, the seats spin round. Sober this must be a disorientating experience, but then sober I probably would not have bought the tickets.  After a few glasses of beer the ride is simply terrifying. Throughout the entire experience I could not place the ground, the direction or the sky come to that.

 

Actually a Monster casts a long shadow across European real estate markets as far as the Messe itself. At Expo there is always lots of beer to drink and food to eat. Traditional dress is much in evidence - particularly striped ties - and this year disorientated participants run away from southern European stands looking for core investments. This monster is macro-currency risk and it is paralysing the markets.

According to the bulls, by Expo Real 2012 the Monster will have moved on and the show will be back to its purposeful best. Others see a much longer ride with more swings of the pendulum before we return to the ground.

What's in a name

Quite a lot really. The name of a place certainly conjures up an image even if it is only a perception. London will get five new places after the Olympics, all named by members of the public, all created from that desperate strip of land running from Bow Road up to Eton Manor – or the Olympic Park as it is currently known.

At the outset let me make clear that I am a big fan of the regeneration that will take place as a result of the Olympics, if not the event itself. I am also very bored with the continued grizzling of some that “the jobs won’t go to local people” or “I could create more jobs than that with £9 billion”.  The fact is that, were it not for the Olympics, there would have been no new jobs, the money would not have been spent and the area concerned would still be in the same state of dereliction in ten years time.

 

That said it looks like “members of the public” have allowed their imaginations to run wild! One of the golden rules for a new place is to make it sound classy.  The view from East London is that Surrey is definitely high-class so what better than to steal a bit of Surrey as a new place. Chobham Manor will be the area north of the athletes village – the views of the inhabitants of Chobham village (Surrey) are unknown.

Pudding Mill has a vaguely bucolic feel to it – at least to anyone who hasn’t been there – but the real eyebrow raiser is Sweetwater. Now, I am sure that the plans for the area involve cleaning up the river Lea, but, looking at its current state, Sweetwater takes a pretty big leap of imagination. Research by University College London, shows the amount of faecal e-coli bacteria in the River Lea is more than 80 times the recommended level. Lovely!

The only name that really fits seems to be Marshgate Wharf, adjacent to the new Stratford City development, which has an authentic, gritty industrial feel to it. Eastwick will be the area east of Hackney Wick – see what they did there? I prefer to think that it has been named after the witches. Perhaps they will invite Jack Nicholson to the opening. 

A phased reopening of the park will begin in 2013, with families moving into the new conurbations in 2015. It will be interesting to see if any differences in value emerge amongst the different communities.

 

How green is my city?

In support of Savills assertion that German offices are green by default - it seems that, compared to other European cities, Germany's urban centers are better than average and among the best when it comes to protecting the climate and the environment. This is the finding of the German Green City Index, an urban study commissioned by Siemens from the Economist Intelligence Unit. 

The study (in German) scores each city in eight areas: Air quality, CO2 emissions, Energy, Buildings, Traffic, Water quality, Litter and Environmental management.

As far as CO2 emissions are concerned Stockholm and Oslo are way out in front but London does pretty well with an above average score alongside Berlin, Paris and Helsinki amongst others. The laggards here are Kiev and Sofia but there are a clutch of below average cities including Dublin, Budapest and Prague.

Predictably, London does badly as far as traffic is concerned alongside Paris and Rome amongst others, but is in the middle of the pack with respect to building standards, energy, air quality and litter. 

The latter feels counter intuitive. Perhaps it is the discarded coffee cups bowling down the road on a stiff breeze or the forests worth of free papers littering the station precincts or just the remains of last night's chicken Dansak thrown out of the car window, but London feels full of rubbish.

As far as building standards are concerned, all the German cities studied are above average with the exception of Cologne. A similar story can be seen as far as traffic management is concerned except the miscreant here is Leipzig - only average I am afraid.

Water quality sees all the German cities above average bar none. London's water also passed with flying colours (five times!). Air quality saw a broader spread with Athens one of the laggards - tear gas probably the reason.

 

 

Baschurch and the Big Society

Since the Beeching cuts of the early sixties removed their station, Baschurch has had an infrastructure problem.  Some 10 miles north of Shrewsbury and 15 miles from the M54, the 1,500 population have, hitherto, been off the pace in the connectivity stakes. This is all about to change. Baschurch has been named by BT as one of six superfast broadband hubs to be delivered in 2012. This follows a nationwide contest to discover where there is greatest demand to get online. Well done them.

The six communities which garnered the highest proportion of support from their residents were Baschurch, Blewbury in Oxfordshire, Caxton and Madingley in Cambridgeshire, Innerleithen in Tweeddale and Whitchurch in Hampshire. Each will get a broadband hub by early 2012 that will allow download speeds of up to 40 megabits per second.

BT is spending £2.5bn on its network to reach two-thirds of homes by 2015 and the project is part of a publicly funded drive to get broadband to all parts of the UK. £830m will be diverted from BBC licence fee revenues over the next seven years to help pay for extending fibre networks to rural areas.

The UK Government wants every community to be within reach of high-speed digital infrastructure using optical fibre by 2015 – potentially, a more ambitious target than the 2Mbps aspiration offered by the previous administration. The Government wants local authorities to bid for public subsidies to build the broadband hubs though how this fits with the financial straightjacket planned for the next five years is not clear.

Clearly, the growth of fast broadband infrastructure is a good thing. For some years now the UK has been significantly behind other European countries in the delivery of capacity in this area, putting the country at an increasing competitive disadvantage. Whether allowing local pressure groups and Local Authorities to set the spatial priorities for investment is the best way forward is, at very least, open to debate.

It sits very nicely with the “Big Society” ethos, but may have limited economic effects. Comparing the six chosen locations, with one exception, they are all satellites of bigger towns with the employment opportunities that offers. Bar one, Innerleithen in the Scottish Borders, they are all significantly above average on indicators of economic activity,  job level and the level of qualifications in the workforce. Even Innerleithen sees above average economic activity and qualifications.

This is not a measure targeted at improving the economic infrastructure in disadvantaged areas, just mildly inconvenienced ones. It hardly dispels the feeling that “Big Society” actually translates as “Devil take the hindmost.”

Risky business

At the European Real Estate Society (ERES) conference in Stockholm last week I sat on a panel discussing international real estate.  We were each invited to speak for five minutes on the theme before the debate was opened up to the floor. This is, upon mature reflection, what I meant to say.

Real estate has experienced significant levels of internationalisation in its market activities over the last decade. These range from the growth of key market players such as real estate service providers and investors to the increasingly cross-border nature of a wide spectrum of real estate activities.

Property is an illiquid, inelastic investment that often comes in inconveniently large lot sizes.  Therein lies its potential to diversify investment away from, for example, equities.  Investing in property directly requires specialist knowledge and expert assistance. For this reason investors tend to be experienced in the sector and have a clear idea of the risk/return ratio that can be expected.  Because of this reliance upon localized, specialist knowledge investors were, by nature, somewhat parochial in their selection of stock, leading to a number of strong national markets but with relatively weak cross-border flows of capital.

The figure above shows som different real estate investment types. Shares in property companies have always provided an indirect route to investment in property as have retail funds of different kinds.  The growth of Real estate Investment Trusts in the US and more recently in Europe provide an additional route, albeit one with more tax complexity and there have been various vehicles that attempt to securitise the income stream provided by property investments.

In recent years we have seen the growth of Mortgage Backed Securities and Property Derivatives completing the full spectrum from simple direct investments to complex indirect vehicles. From a risk perspective, this spectrum runs from an expert investor, keenly aware of the characteristics of the asset to a naïve investor who relies entirely upon a rating agency to classify risk. In other words the investor has lost contact with the underlying asset.

In some respects this is not a bad thing. It means that it is no longer necessary to employ real estate specialists to oversee the investment process; it means that property assets can be compared wherever they are located and, although some of the diversification potential has been lost, it has become far easier to trade the asset. So, provided that valuations accurately reflect the risk being taken everything in the garden is rosy!

In an environment where remuneration is heavily geared towards transaction it seems incongruous that, in many cases, valuations are undertaken by the same companies that buy and sell the assets under consideration.  That is, of course, assuming that the properties are valued independently at all.

Ratings agencies have picked up significant criticism about their performance in this recession although it is difficult to see how they could have performed better, short of being more prescient. The real issue here is the investor’s lack of understanding of the ratings system itself.

To process the volume of products requiring rating and to monitor them continually, ratings have to be based upon modeling potential performance against highly standardized benchmarks. It is an industrial scale process a world away from the hands-on, bricks and mortar approach of direct investment because it simply could not be done any other way.  It is flexible, reactive and it can change ratings quickly. Typically, the ratings agency is paid by the seller rather than the investor.

Models, of course, are only as effective as the data they use.  For much international property, transparency of data is a big issue, even in mature, sophisticated markets like

Germany

.  Where there is no standardized data collection of, for example, transaction data, those involved with the transactions themselves have the opportunity to colour the data in their favour.

Good quality research should flush this out, however, there is a tendency to assume a level playing field between markets and make direct comparisons between markets and sectors where the quality and quantity of data are vastly different, increasing the potential for volatility.

Where do we go from here? Clearly there has been a breakdown in trust that needs to be addressed.  Already more regulation of indirect investments is being mooted by the EU particularly.  Some of this is fully justified, but you can’t regulate against investors making bad decisions. What you can do is ensure that they make informed decisions.

To get there we need three things:

·         Increased transparency throughout the entire process.  Investors need to be able to see the full data picture and regulators need to know where the assets are held and by whom;

·         Increased independence with respect to valuation and research. Valuations need to be mandatory and independent of process.  Investors need to be aware that free research is accurately valued;

·         Different remuneration models.  Bonuses need to be tied to long-term performance rather than to the transaction itself and investors need to pay for the rating of vehicles rather than being spoon fed ratings selected by the seller.

If we achieve all that – and I fear it is unlikely in the medium term – we will be able to start taking an holistic view of risk that is linked to the real values of the asset class and make informed decisions about international property.