Why global real estate remains a lousy investment

Posted on 04 October 2010 with 1 comment from readers

The Cityscape Global real estate conference and exhibition opened in Dubai today. Sadly the clear message from the first sparcely-attended session of the conference is that global real estate presently offers very low returns with very high capital risk.

Even at a show designed to promote real estate this conclusion is hard to brush over. For the low yields on property and treasury bonds point to a fundamental issue: there is not a big enough return to encourage investors.

Low return, high risk

Why would anybody take a capital risk for a 2.5 per cent return? Yet that is what property in many developed markets is paying today. But that is not the full story.

Only because interest rates are so low is the capital value of this property being maintained. If interest rates go up then property prices will go down and the yield on property will go back up.

This is what is going to happen. The rising yields on bonds in Ireland are an example of how this is going to pan out across the world. Basically in order to borrow more governments will have to offer investors higher interest rates.

Present yields on bonds are unsustainably low, and when the bond market tips over the reversal to higher rates will likely be swift. That will raise the cost of owning property, lower the demand and reduce prices.

This fundamental problem is why even long-term professional property investors like Tom Barrack Junior, manager of the $45 billion Colony Capital property portfolio, are cautious these days.

He warned Cityscape Global that real estate investors had gotten used to upward only market returns for 20 years and that there were now ‘very few growth scenarios’.

Chindia

Even in China and India the pricing of real estate is presently way ahead of fundamentals and vulnerable to a correction as global interest rate levels rise, argued Sam Chandan, CEO of Real Capital Analysis. He warned that this correction would impact on exporting economies like the Gulf States.

It was a sobering message. Property investors are therefore perhaps best advised to be cautious and save their money for a better market. In the near future real estate prices should be much lower and yields far higher, and that would be a good time to invest, albeit probably will less debt as borrowing costs will be much higher.

Then the real estate market will be reset for the resumption of the virtuous cycle from lower to higher prices as leveraging gradually returns. And these investors will be the ones who get double-digit returns again, not anybody ignoring this advice today.