Hanging on for the ride
The NCREIF index, despite its shortcomings, is often cited as the best benchmark for the private equity real estate industry. Judging by the performance of the NCREIF over the past year— nay, the past 28 years—it's been quite a ride.
Since the beginning of 2005, the NCREIF property index has grown by approximately 14 percent, roughly comparable to the return of 14.5 percent posted in 2004, the second best annual performance since 1981. Beginning in 1977, the year the index was created, the NCREIF has produced an annual yield just under 10 percent, a performance roughly on par with the historical returns of the NAREIT index, which tracks the performance of publicly traded REITs.
There are signs, however, that the ride may be coming to an end—or, at the very least, slowing down. The recent volatility in the NAREIT equity index, which has fallen by approximately 5 percent since July, has coincided with a brief dip in the quarterly growth rates of the NCREIF. Time will tell if the era of excess historical returns is over, but 2006 should still bring some welcome news from the NCREIF—an opportunity fund index is currently under development and will be unveiled next year.
Looking at the historical returns generated by the NCREIF property index (see chart at left), it's understandable that investors, institutional and otherwise, have been increasingly targeting the real estate market. But all those dollars need to be spent and, if 2005 is any indication, being spent they are.
According to Real Capital Analytics, approximately $187 billion worth of property sales took place in the first three quarters of the year. That already represents an increase over the entire twelve months of 2004, a year in which sales volumes grew by more than 50 percent relative to 2003.
This robust activity has in turn led to a further compression of cap rates across all major property types. In the apartment, industrial and office sectors, for example, cap rates have fallen by more than 60 basis points since the end of 2004. But as with the rise of the NCREIF, the decline in cap rates have not been confined to the current year. Since the first quarter of 2001, overall cap rates have fallen by more than 270 basis points, while each property sector has witnessed declines of at least 200 basis points.
Old World charm
Over the past ten years, Europe's tradition-bound real estate market has been slowly transformed by a steady and growing influx of private real estate funds. As evidenced by this chart, that trend has only continued in 2005.
Since the beginning of the year, the gross asset value of European private real estate funds, excluding German openended vehicles, has grown by 25 percent, the highest annual growth rate in the past five years. Today, there are 393 of these vehicles with a combined gross asset value of €167.5 billion according to the European Association for Investors in Nonlisted Real Estate Vehicles (INREV).
Though opportunity funds have increased substantially since the mid-1990s, their growth stalled somewhat in 2005; perhaps reflecting the more risk-averse nature of European investors, it is core and value-added funds which have substantially grown over the past two years. Earlier this year, Andrew Baum, chairman of Oxford Property Consultants, told PERE that “value-added has become the new opportunity.”
Nevertheless, the emergence of both Western and Eastern Europe as a destination for private equity real estate firms suggests that funds across the risk-return spectrum will continue to make their mark on the European real estate industry.
Growing piece of the pie
Though statistics on real estate activity in the Asian markets are difficult to come by, one observation makes all other statistics irrelevant: the market is very, very big—and hence, quite attractive to real estate investors.
According to a recent paper published by the European Public Real Estate Association (EPRA), based on research from the World Bank and FTSE, high-quality commercial real estate in the Asia-Pacific region totals approximately $3.2 trillion dollars, roughly a quarter of the worldwide market and approximately 60 percent of the size of US or Europe.
Yet while Japan contains the bulk of the region's high quality real estate, explaining why so much private equity real estate money is targeting the country, the large and developing markets of China and India are still relatively insignificant. Combine the lack of high-quality real estate in these two countries with their huge populations, growing domestic economies and substantial land masses and the opportunity in the region becomes abundantly clear.
The potential growth across Asia, both in terms of private and public real estate, is highlighted in the report, which predicts that “the market capitalization (currently $565 billion) of the FTSE EPRA/NAREIT will reach $1 trillion in the next five years.”