By Tom Leahy on July 9th, 2020
Willem Vlaming provided the data analysis for this article.
Investors of all stripes have a well-known tendency towards loss aversion and academic literature has consistently described that property owners tend to sell winners and hold losers.
Therefore, at this time of market dislocation – when deal flow is down substantially and assets may be forced onto the market, either because of breached covenants or liquidity requirements – we have looked at how far prices would have to fall in the major global markets for owners to see their gains wiped out.
The analysis has important implications for liquidity. Those markets where a greater proportion of investors will stay in the money in the event of small-to-medium prices falls are likely to remain more liquid than those where a greater proportion of investors would experience losses in the event of the same drop in market pricing.
The chart shows that London, where the rate of price growth has been modest since the Brexit vote in June 2016, looks more vulnerable than a market like San Francisco, where the rate of price growth is such that prices would have to fall by a very significant amount before a majority of investors would likely experience a loss on their assets. (The analysis is based on deal volume for office, industrial and retail properties that have traded at least once since 2007.)
Hong Kong is the outlier among the major global markets shown. Prices have already fallen very sharply from their Q1 2019 peak, which means a significant percentage of the current owner base would, on average, realize a loss were they to sell. This is reflected in the volume statistics, which have cratered in the first half of the year.
However, there are some important caveats to this analysis. Firstly, the pricing movements are all calculated at a metro level and hide a whole myriad of variation at a property level. All the factors that feed into property pricing will affect each asset to a varying degree and investors selling an asset in July may achieve double-digit returns in London just as they may achieve single-digit returns in Paris or San Francisco or any of the other markets shown.
Second, while volumes and deal flow have plummeted in the wake of the Covid-19 lockdown, property prices in the direct market are yet to shift significantly. Analysis from the MIT Center for Real Estate Price Dynamics Platform indicate buyer and seller expectations have moved further apart since the start of the crisis and this may presage a softening in prices, but the weight of capital and low rate environment may be cushioning pricing for the better quality assets.
Anecdotally, we know that deals for good quality assets are completing with very small price adjustments to those agreed pre-crisis, but it is only when the market opens up fully and a broader spectrum and type of properties start to trade that we will have a better signal on where prices are going in the second half of the year.
Real Capital Analytics produces more than 350 price indices which provide direct comparability across markets and property types in 15 countries. If you would like to learn more about these indices, please contact us. The next RCA CPPI Global Cities report will be released August 13.
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