Commercial Real Estate Heading For A Deep Freeze

(By Anthony Harrington via QFinance) One of the clichés of real estate investing is that you can make more of everything but you can't make more land. The implication is that real estate has to be a one way bet. More people competing for a share of an asset that can't be expanded very readily must equate to constantly rising prices, or so the law of supply and demand might seem to suggest.

The constantly increasing cost of office and residential property in the world's top cities provided an obvious case in point through the 20th century and for much of the first decade of the 21st Century. Before the 2008-2009 global financial crash, investments in commercial and residential property regularly generated year on year total returns of over 15 percent. When both rental income and capital growth were combined, the returns in the more spectacular years could be north of 20%. No wonder real estate caught the attention of investors.

However, what this cliché about the nature of land does not take into account, is that the real estate sector is particularly prone to developing asset price bubbles which go unnoticed in their formative stages. Before the catastrophe of the United States sub-prime mortgage debacle, the loosening of lending criteria for home ownership in the US was justified again and again on the grounds that there had never been a collapse in house prices in the US. Before the crash of the Tokyo stock market property values in Japan had soared to unprecedented heights, with one bedroom flats selling for in excess of the Yen equivalent of a million dollars.

China today is desperately trying to craft a soft landing for its economy despite a massive bubble in the Chinese property market. The Spanish economy is floundering largely because its major and minor banks all have massive amounts of underperforming property loans on their books. The Irish Government's efforts at bailing out its banks, which blew up after a decade of disastrous lending on property, left Ireland needing billions in EU bailout funding, and its citizens are now facing a bleak future.

The lesson to be drawn from this is that investing in property is very far from being a safe, one way bet. Property has its attractions and its disadvantages as an asset class. The enduring disadvantage is that by its nature, property is an illiquid asset class with extremely lumpy exits. When you invest in a building you are clearly not thinking of selling it next week, and probably not in the next five to ten years. Property funds do churn their assets, but by comparison with active equity managers, they move in a geological time frame.