Risk premium for secondary assets increasingly ‘compelling’

The bifurcation of global real estate markets has seen the spread between prime and secondary property yields and cap rates widen by up to 400-450bp, with more LPs expected to target the sector in developed markets in 2011, according to ING REIM's latest outlook report.

Institutional investors could start moving up the real estate risk spectrum as the premium between primary and secondary assets in key global cities widens to one of its largest points in history.

The gulf between core and value-added assets in many developed real estate markets has risen to between 300 and 400 basis points, according to the latest outlook from ING Real Estate Investment Management. In the UK, the spread has risen in some cases to between 350bp and 450bp, a spread that is “as wide as it has ever been,” Tim Bellman, global head of research and strategy told PERE.

As a result, the risk premium currently being seen between core, or prime, properties and secondary assets located in strong markets was “compelling”, Bellman added. “For more and more managers, this is the way to get outstanding returns in the period ahead,” he said in an interview. “We are not saying this is a ‘buy all secondary properties’ moment, but by selectively acquiring secondary assets, this is really quite an interesting time.”

The ING REIM 2011 global vision report, published today, stressed recovery prospects in developed markets, such as the US, UK and Continental Europe, would be strongest in the near term, with institutional investors adopting a “home bias” to take advantage of an “uplift in values on top of a favourable income return”.

Bellman accepted fears that weak job growth would not result in a recovery to 2007 employment levels for between “five and 10 years”. However, he said occupational markets in many developed countries have proven “more robust” than many expected. “Commercial real estate didn’t deteriorate as much as people thought,” he said.

Investors, therefore, wanting to take advantage of the recovery prospects should target “cyclical sectors such as hotels and offices and take an overweight position to the Americas”, particularly the US for possible short-term gains and Brazil for longer-term opportunities.