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Sam Johnson

The real estate market in brief

The following is the first of a two-part introductory series, where readers will be provided with a primer on the industry and the macroeconomic factors that contribute to it. My goals of the column are three-fold: to inform and educate students as to the function of real estate markets; to provide analysis on a number of past, present, and future trends in the sector; and to provide real estate-oriented investment advice.I hope to portray the industry as more than mortgage-backed securities, cavalier developers à la The Donald, and traditional forms of property investment. Real estate’s big pictureMost of us take for granted an understanding of the broader macroeconomic side to real estate. Unfortunately, the 2007-09 real estate collapse put the sector at the forefront of national media coverage; the everyday individual realized the realized the real estate market’s unpredictable, potentially destructive influence. That said, the importance of the housing sector as a positive economic driver is often overlooked. In the United States, the residential real estate market alone perennially constitutes 16-18% of total GDP. Historically, real estate has had powerful pro-cyclical factors, and its various forms have served as significant drivers of economic recovery from most US recessions since World War II. Federal Reserve Chairman Ben Bernanke has stated that the continued weakness in this sector is a primary reason for the “frustratingly slow pace” of the economy in recent years.In its simplest form, real estate can be divided into two main subsectors: the commercial sector (income-producing properties used for investment purposes such as apartments and office buildings) and the residential (including multi-family homes and condominiums). Both of these subsectors can be analyzed with the classic ECON 101 supply-and-demand curves, with rental or lease rates acting as the price-clearing mechanism that establishes equilibrium. If a residential sector unit is owner-occupied,… Read More

The real estate market in brief, part 2

This is the second article in a two-part introductory series. While the first piece looked at the broader macroeconomic landscape in real estate, I will now move on to an examination of the investment side of the sector. The investment market explainedThe largest buy-side institutional investors (in Canada, these would be the pension funds such as OMERS, CPP and OTPP) have traditionally allocated between 8-10% of their investment portfolios to real estate assets. In the wake of global liquidity crisis, overall transaction volumes dropped: by 50% between 2007 and 2008, and by a further 44% between 2008 and 2009. Jones Lang LaSalle forecasts the highest annual volumes since 2007 at $440 billion in 2011, marking a 40% rise on 2010.As a form of alternative investment, real estate provides excellent diversification benefits due to its “inflation-hedged” nature. Inflation-hedged assets are investments with intrinsic value that tends to appreciate relative to the rate of inflation. Real estate investments are also negatively correlated to stocks and bonds, making them excellent counter-cyclical buffers in any portfolio. High-quality, central-business-district commercial real estate embodies many of the same characteristics as traditional safe haven assets such as gold.Property classes in which capital can be invested include: office, retail, industrial, multifamily (apartments), hospitality and hotels. Each sub-sector has different characteristics and reacts differently to the economic cycle.Since 2009, as the US home ownership level has plummeted to 66%, the demand for rental units has skyrocketed. The multifamily/apartment sector has been this trend’s main beneficiary as heightened demand drives up occupancy rates, rents and, ultimately, investment returns. Robust sector-wide demand has let apartment-based investments such as CAP REIT experience a year-over-year capital gain of 24.12%.Within each subsector there are three primary investment vehicles. The traditional form of investment is private equity, where physical properties are acquired and leased in… Read More

Real estate asset bubbles, part 1

There are many ways by which the economies of Vancouver and Brazil differ dramatically: a roughly ten-fold disparity in GDP per capita, a stark gap in the rate of economic growth, and the very fact that neither can be accurately compared on the basis of scale alone. Vancouver is a relatively small city of 2.3 million people, bounded by mountains to the east and water to the west – an important feature that constrains the physical capacity for future development. With a GDP of over $2 trillion, the country of Brazil is the seventh-largest economic powerhouse in the modern world, and has a vast landscape ripe for expansion. Though the regions share few similarities, they have experienced a convergence of sorts with the beginning of a phenomenon that threatens to rock the very economy upon which each depends. The culprit has been a red-hot, unrelenting infusion of foreign capital, a sizable portion of which has been injected directly into the heart of the real estate sector. As we will see in this article, it will take the utmost care and precision of policy makers and market participants to prevent these de-stabilizing flows from delivering a disorderly shock to an industry commonly regarded as an economic lifeline.My aims are two: to establish the extent to which these two scenarios compare, and, in light of recent property-bubble-related collapses, to examine the extent to which foreign capital flows can damage the local real estate environment.VancouverIn Vancouver the overwhelming majority of new capital flow is due to an influx of new Chinese buyers – a phenomenon that Bank of Canada Governor Mark Carney himself has publicly acknowledged.While these flows are difficult to quantify, the roots of the phenomenon can be traced back to the end of the financial crisis in 2009. As the economy stagnated,… Read More

Real estate asset bubbles, part 2

To what extent have real-estate bubbles in Vancouver and Brazil affected domestic markets? What risks do rising property values pose to local communities?The largest downside risk of the capital-flow-driven escalation in prices has to do with the potential for a disorderly debt-deflation cycle. On the simplest level, rising property values force residents to leverage up in significant amounts in order to keep pace with price increases. As property values increase and incomes remain stagnant, there must be a proportional increase in the size of the mortgage loans taken out by homebuyers.Rising property values also create a dangerously alluring ‘wealth effect,’ whereby increasing equity in one’s property holdings leads to false optimism and a tendency to borrow further; it is the common fallacy of feeling ‘richer’ as your house gains in value.In Brazil, this has led to residents exceeding their debt-servicing ability in order to buy higher-end consumer goods. Some media outlets have reported people borrowing from one lender to cover their equity down-payment to another.In Vancouver, the situation is no different. An article was printed in The Globe and Mail last week entitled, Beware ‘the housing wealth effect,’ which described Canada’s rising appetite for consumer debt in the face of elevated housing prices.The average Vancouver resident now pays approximately 72% of his or her annual household income in the form of mortgage debt servicing alone, while Canada-wide home equity lines of credit for cars, vacations, and the like have increased 95-fold since 1985. The IMF’s September 2011 World Economic Outlook states the following:“In per capita terms, credit close to doubled in real terms during 2005-2010 … faster than nominal GDP in a number of economies … this raises concern, as credit growth is likely to come at the expense of deteriorating credit quality.”It continues,“High credit growth coincides with rapid increases… Read More

Diversify your portfolio: REIT analysis

Equally as important as a macroeconomic analysis of real estate, and perhaps more interesting, is an examination of the equities market in this sector. Although an analysis of these securities is quite similar to that of regular equities, it is worth identifying the idiosyncrasies of this investment class so that you may give them the consideration they deserve as part of your future portfolio mix. Asset Profile:Real Estate Investment Trusts, or “REITs” as they have become affectionately known, are high-yield, dividend-paying stocks that invest in various classes of commercial real estate. Although non-traded REIT’s do exist, the vast majority are traded on the major exchanges like traditional equity securities. These trusts are legally obligated to pay out at least 90% of their net income in the form of dividends to shareholders.  In return, they are exempt from paying income tax.For each individual property in their portfolio, margins are generated on the spread between the profits on cash flows from rent or lease rates, and the lending rates at which these firms borrow to finance acquisitions. REIT’s do generate profits from strategic asset sales and non-core divestitures, but these revenues are not typically counted in the determination of key valuation metrics.Although acquisitions are also financed with newly issued equity via initial public offerings, REIT’s remain highly leveraged businesses, with leverage to market capitalization ratios that can exceed 50%, and leverage-to-EBITDA multiples that are much higher than firms in other sectors.Like dividend-paying equities, investors receive two forms of investment return; periodic dividend distributions, which make up around 70% of the distribution, and potential capital gains on the share price at the time of liquidation. With such a high dividend payout ratio, REIT’s may initially seem like steady investments with limited downside risk, and while this may be true at times, the performance… Read More
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