WATCH: The biggest risk in global real estate

Rob Wilkinson, chief executive at AEW Europe, believes the biggest risk the private equity real estate industry faces today is rising interest rates resulting from the tapering of quantitative easing. The major concern about rising rates, however, is not how they may affect the ability of property investors to repay debt, but how rate increases may lead to sizable dispositions that could in turn have a negative impact on real estate pricing.

Transcript

I think right now in the current environment the biggest risk we face is how governments implement monetary policy as we go through the tapering of QE. We potentially see inflation coming back into the market and the risk is that leads to significant movements in interest rates.

And whereas I don’t see that having a major impact on investors who may have used leverage in acquiring real estate because levels of leverage overall are much lower than they were say 10 years ago, the bigger risk is that the asset allocators who have a significant bond portfolios will see those reprice as the interest rates obviously go up which will mean their real estate portfolios will also increase in allocation.

And that leads to the risk that they automatically decide to sell real estate – indeed perhaps for the wrong reason at that time – and if there is that oversupply into the market obviously that could create some damage to prices in real estate.

The reality is the consensus view among most investors that there is something of a rise in interest rates coming but it’s relatively gradual, relatively minor and because to some extent most of them are still underallocated versus their target for real estate, that still creates some demand.

That said I do think it’s true that because of the investment activity that’s been in the last three to five years which has been very sustained, very high, some of them have increased that their allocations during that period. So I do think right now that people are thinking about how much real estate they might want to buy going forward, although I still think they will, and perhaps that’s not as much as previously because with their interest rate forecasts, they do see some increase but again most of them are expecting those to be quite gradual. They’re still investing but perhaps with maybe not the same intensity as they were say two years ago.

But that also raises the question of where that capital is coming from. And so this would apply I would say particularly as we focus on the European market, the European investors have been buying but that capital could also be replaced by other investors from Asia, for example from Japan, where the capital within that market has yet really to deploy. So some of it could actually rebalance and replace that capital as well.