INTELLECTUAL PROPERTY: Bubble, bubble, toil and trouble

After a year of mass write-downs it’s hard to imagine anyone warning against another real estate bubble. Indeed, if predictions are to be believed, commercial and residential real estate prices still have a way to fall in the US as the economy struggles to pick itself up off the floor and dust itself off.

However, Starwood Capital founder Barry Sternlicht fears a liquidity bubble is starting to emerge in asset classes such as real estate, as investors desperately seek a home for their capital. Faced with low interest rates, Sternlicht told a New York property forum recently a cadre of “capital tourists” were beginning to pile their cash into real estate markets, particularly listed property securities, in a search for yield.

In a flight to quality, many investors are focused exclusively on trophy assets and the very best a great market has to offer. Few deals fit that parameter, leaving fund managers to sift through the rest of the debris of the real estate crash relatively alone.

was, he added, a case of history repeating itself. “We have no memory as a nation. We are doing it wrong over again. The markets are re-equitising. There's a liquidity bubble forming … The credit markets are healing … they are over-heating.”

Perhaps over-heating is too strong a term, but Sternlicht raises a crucial issue facing real estate investors as they look to the opportunities at hand; namely the possible emergence of mini-bubbles owing to the sheer amount of capital sitting on the sidelines.

Few can quantify the exact volume of cash sitting on the sidelines waiting to take advantage of the next real estate opportunity, however estimates regularly place the figure in the hundreds of billions range. And that’s just taking into account US-based real estate investors. As Sternlicht noted, foreign investors – along with non-traditional property investors – are also hungrily eyeing US real estate because to them it seems cheap. “The US is on sale for foreigners,” the Starwood chief executive officer added.

A case in point was the sale in January of 1625 I Street in Washington DC, a fully leased 85,000-square-foot office building roughly two blocks from the White House. A group of wealthy investors represented by HSBC Alternative Investments acquired a 90 percent stake in the building for $203.4 million in debt and equity. The deal values the property at about $587 per leasable square foot, one of the highest prices paid per square foot – and for a building – in Washington during the past 12 months, according to real estate data firm Real Capital Analytics. Only the August 2009 $207.9 million purchase of 1999 K St, NW by Deka Immobilien from Vornado Realty Trust beat that figure, with a price per square foot tag of $835.

For strong assets, in strong markets investors will fight for the right to buy. HSBC was one of five strong offers (on top of numerous bids) the seller, Brookfield Properties, received for the I Street office, the firm’s chief executive Ric Clark told the Wall Street Journal. “There’s a lot of capital around the world particularly in countries whose currencies have floated up versus the dollar,” he said.

Indeed, Brookfield might have been able to push the price up further as it agreed the deal earlier in 2009 before finally closing in January. “Things have moved in sellers’ favour since the deal was struck,” Green Street Advisors’ senior analyst Michael Knott told the WSJ. “My guess is if they had to do it over again, they would require higher pricing.”

For sellers, the (slowly) rising tide of liquidity into the market is certainly good news. With little product coming to market, competition for the best quality real estate assets will remain tight, helping drive up prices from their lows of 2009.

But private equity real estate buyers can also take some good news from the emergence of these “capital tourists”, as Sternlicht calls them. In a flight to quality, many investors are focused exclusively on trophy assets and the very best a great market has to offer. Few deals fit that parameter, leaving fund managers to sift through the rest of the debris of the real estate crash relatively alone.