EDITOR'S LETTER: Conventional wisdom under threat

You need a view on fixed income markets to be a real estate player, now more than ever, delegates at last month’s PERE Europe Summit in London heard.

Given today’s inflow of institutional money from fixed income allocations to real estate allocations, that view is almost certainly right. But then what is the right view to have about what is happening in the fixed income markets and their correlation with what should be done in real estate right now?

One answer depends on how you benchmark performance. Should you measure property performance against prior cycles, or should the measurement be made in terms of margin over fixed-income alternatives? While opinion varies slightly, there is a consensus that around a 200 basis point minimum margin between property yields and fixed-income products is the right view. That is price of risk inherent with actively managing a hard asset versus an asset management-light paper product. Many investment managers use that margin over fixed-income returns as their yardstick.

Yet, it seems that many managers, and indeed many investors which are transacting directly, are operating with more of an eye on prior real estate market cycles. Take institutions emanating from countries with zero or negative interest rates right now.

The margin between their domestic fixed-income options and even the most prime real estate at home or abroad is well in excess of 200 basis points and yet many seem to be reducing their rate of deployment. Some are seeing 300 basis points or more difference on deals and yet cannot reconcile with historically low property yields.

This is about mental adjustment. If we are indeed going to be operating in a low-to-no interest rate environment for the next decade, as the indicators suggest we are, and if 200 basis points really is the margin of acceptability, then the seemingly ever growing capital pile available for real estate investment right now has some headroom in which to invest.

Understandably, nobody wants to be caught with their pants down. And with geopolitical uncertainty playing havoc with stock markets and currencies, it is human nature to ensure at least certain short-term issues are resolved before pressing on with any paradigm shift. As you read this the EU Brexit vote will have been decided and we’re not far off Trump v Clinton for the White House. It will be fascinating to see if this year’s dipping quarterly investment volumes reverse trend when there is greater political clarity. Because if they do not, today’s benchmarking wisdom will be provably flawed.