An almost universal real estate investor assumption today gives everyone some comfort that values won't fall too precipitously. That assumption is there is somewhere in the neighborhood of $300 billion in equity capital waiting on the sidelines to snap up bargains and keep a floor on pricing. This money includes sovereign wealth funds, pension fund dollars committed to opportunity funds, foreign institutional monies as well as high net worth capital.
Someone very wise and close to me always pounded into my head "don't make assumptions." So let's examine several counterpoints that may chip away this cushion.
First of all we have the return of the denominator effect. The bear market has reduced stock values and increased the percentage of real estate in overall pension portfolios. That means many pension plan sponsors will look to reduce property holdings or at least hold off on new real estate investments until their portfolios have been re-balanced to meet their asset model targets.
We haven't had any backlash yet, but at some point the politics may work against foreign entities buying up our choice U.S real estate, especially if spotlighted as the gains from Middle East oil regimes gouging us at the gas pumps. Some of these sovereign funds got burned badly backstopping major investment bank declines earlier this year before the full extent of exposures to bad loans was known. These generally savvy investors may now wait until real bargains appear on the real estate front before extending themselves. In any case these cash-flush international players will continue to focus on prime, trophy properties (like the Chrysler and GM buildings) in the best markets. New York and San Francisco may benefit from their infusions. It's doubtful secondary or tertiary markets will derive any support or interest from them.
Economies outside the U.S. are following us into a funk. Europe is cooling. What happens to China after all the Olympics hoopla as the rest of the world reduces consumer spending on their prodigious exports? Will foreign investor fervor in the U.S. slacken despite the generally weak dollar or will the dollar start to strengthen more, making buying opportunities here somewhat less attractive in any case?
The world remains an extremely unsettled place, ripe for stopping investors in their tracks. We're one event away from rekindled Mideast turmoil which sends oil prices back up whether in fractious Iraq, the powder-keg Israel/Palestinian territories, or snarly Iran. Afghanistan gets worse. And now Russia flexes its restored muscles (thanks to petro power) in Georgia and signals a willingness for confrontation on other fronts. Who knows what could happen?
Lastly, the debt markets remain in intensive care and highly risk averse. Equity buyers preying on motivated sellers can't depend on leverage strategies to juice returns. Even that $300 billion on the sidelines assumption can't come close to filling the gap in missing debt capital from the marketplace.
Never make assumptions.
This article brings up some excellent points about the risks of real estate.
Posted by: Zane Waltz | August 12, 2008 at 07:32 PM