By Tom Leahy on December 6th, 2017
Investors are pushing into Europe’s secondary and tertiary cities in greater numbers as commercial property prices in the region’s core markets test record highs. These buyers should be aware that in many of these smaller markets, such as Dublin and Leipzig, liquidity is well above historical trends. Does this mean these investors should be worried? The short answer is maybe, the longer answer is maybe not.
One of the main uses of the recently-launched RCA Capital Liquidity Scores is to help investors quantify liquidity risk, allowing them to compare current market liquidity to long-term averages and help inform investment decisions. The scores aim to measure the depth and breadth of capital targeting a market, with a belief that the greater the amount and diversity of capital, the more liquid a market is.
In Europe, the list of markets where liquidity is riding highest above average reflects how much the breadth and depth of capital targeting secondary markets has increased. Of the markets with capital liquidity scores furthest ahead of their long-term averages, none are ranked in the top 15 largest European markets.
Investors acquiring property in a market such as Leipzig, where the capital liquidity score is almost double its long-term average, should be aware that it is possible they will be selling assets into a less liquid market in the future. That is to say, a future where the amount and diversity of active capital is less than it is today. This has implications for stock selection and price expectations on exit, especially with the period of monetary stimulus that has driven so much capital into real estate gradually drawing to a close.
On the flip side, attitude to this risk can also be influenced by whether one believes a change has occurred that makes a market structurally more liquid. In Dublin, regulatory changes, the presence of international occupiers, and the replacement of debt-driven private investors by institutional and REIT capital might demonstrate that a capital liquidity score 1.67 times the average signals the positive structural changes made since the Global Financial Crisis.
All other things being equal, investors expect to be compensated for the greater risk they adopt in less liquid markets by buying at higher yields. In Germany, prime yields in the Big 7 markets average 3.4%, as opposed to 4.8% in Leipzig. This equates to an almost 30% difference in capital value, as compared with an average 30-point difference in capital liquidity.
Investors must decide, therefore, whether the price differential is sufficient to offset the greater potential risk presented by investing in markets where liquidity is well above average, and where they could be selling assets into a market without the breadth and depth of capital currently active.
The aim of the capital liquidity scores is to help investors make more informed decisions when they enter secondary and tertiary markets.
Real Capital Analytics launched the RCA Capital Liquidity Scores in November 2017. If you are an RCA client you can access the RCA Capital Liquidity Scores report, data file, and methodology document on the RCA website.