5 tips to help real estate investors prepare for downturns

Money will continue to flow into real estate from across the capital markets. But investors should be increasingly concerned about getting caught late in the cycle, and anticipate the next cyclical downturn in a few years, finds LaSalle Investment Management’s 2015 Investment Strategy Annual (ISA).

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With different regions of the world growing at different speeds, investors need to prepare their portfolios for a world where interest rates begin to rise more quickly in some parts than others.

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Here are some tips.

• Diversify holdings across a number of countries that are in different stages of the capital market cycle.
• Anticipate different interest rate environments by allocating to real estate assets with income streams that keep pace with rising inflation or debt costs in growing economies like the U.K. or the U.S..
• Focus on high quality properties and locations in markets where growth/interest rates will stay lower for longer, such as Japan or Western Europe.
• Invest in secular trends, rather than cyclical ones, that will be less exposed to a downturn.
• Place a high emphasis on sustainability factors, like energy efficiency and recycling, when buying, improving and operating buildings. Tenants and the capital markets will be paying much more attention to environmental standards in the years ahead.

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“Investors are concerned about what might happen if capital markets turn away from property,” says Jacques Gordon, global head of research and strategy, LaSalle. “Timing strategies are difficult to apply to a relatively illiquid asset class like real estate. Nevertheless, adjusting portfolios as assets and markets move through their respective cycles can improve performance by enhancing returns and reducing risk.”

He also notes that markets around the world are at very different stages in terms of market fundamentals and capital markets, and hence future performance. So it makes sense to have an investment program that takes advantage of real estate cycles. Examples of cycle-sensitive strategies include: harvesting gains and selling properties in frothy capital markets; taking advantage of higher levels of leasing/rental growth in growth markets; and focusing on locations/sectors that are positioned to qualify as mainstream core assets in a few years.

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Additional findings include:

• money is likely to continue to flow into real estate as long as the yields on property continue to offer a premium to investment-grade bonds;
• the debt markets are also embracing real estate, although lending is not yet as aggressive as it was during the peak of the credit bubble;
• taken together, this is likely to keep pushing prices up, while continuing to lower the expected future returns on real estate; and
• it could also lead to an escalation in new development. After many years of low levels of new construction in nearly all G-20 countries, most major markets can easily absorb moderate additions to inventory without creating an oversupply problem.

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Canadian trends

ISA predicts that Canada’s near-term economic growth in 2015 will trail the U.S., yet remain ahead of most other G7 countries. While slower global growth could impact demand in Canada’s resources sector, improvement in the U.S. economy will benefit Canada in the form of stronger export volumes in 2015 and beyond. Private consumption is forecast to grow more slowly in 2015 given elevated housing prices and high household debt levels. Stronger business investment and government expenditures should partially offset this.

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Growth in the Alberta oil sands will slow in 2015 as oil prices face downward pressure and U.S. production escalates. However, traditional oil and gas drilling is re-emerging as fracking technology improves and pipeline expansion delays have been alleviated by significant growth in rail transport. Consequently, economic growth and real estate demand in cities in Western Canada will continue to outpace the nation.

In addition, e-commerce adoption will continue to grow as a share of overall retail trade and drive further changes among retailers and distribution chains in Canada. Retailers with a proven, established e-commerce platform will grow at the expense of those with less efficient or no models.