The Barclays view
Contributed by Michael Dicks, Chief Economist at Barclays, who has over 20 years' experience researching housing and property markets. Here he provides his opinions on some of the survey findings.
We found a number of the survey’s findings surprising. Most obviously, survey respondents are clearly holding a much higher proportion of their wealth in property than we would normally advise.
Investors need not only to diversify more into other asset classes, but also to make sure that their property portfolios are themselves much less concentrated than they seem to be. Survey respondents’ property portfolios also appear to suffer from “home bias” (i.e. a tendency to be too strongly tilted towards the individual investor’s home market). So, they need to be better diversified on a geographical basis.
Survey respondents also seem to believe that, as an asset class, property delivers high long-term returns, when, in fact, it typically has not done so. When considering risk-adjusted returns, the asset class does not score very well either. Investors appear to believe that housing provides a ‘safe’ investment, when it clearly does not: witness, for example, the near one-third decline in the real value of housing in the United States over the past two years – which is almost exactly the average such decline that has occurred in real house prices in 15 other economies that have experienced banking crises during the past three decades. Linked to this, survey respondents’ expectations of high rental returns from investing in residential property seem to us to be very unlikely to be forthcoming, as most other experts surveyed in the report suggested too. However, in some areas, investors’ misperceptions may work in the other way. Capital gains expectations, for example are typically extrapolative, and hence normally overly optimistic at the top of the cycle and overly pessimistic at the bottom of one. So, currently the asset class is probably more attractive than generally believed from this perspective.
To put this observation another way, the tactical investment advice that we offer clients runs counter to the strategic advice that we provide them with. Over the long term, as noted above, we would suggest a (much) lower concentration on property than the survey respondents appear to hold currently. In the short run, by contrast, they should be long their benchmarks, as the asset class now looks cheap in some parts of the world (such as the US).
Investors may find it useful to consider their property holdings in the light of our forecasts for the sector, summarised below, and detailed in our regular publication.
Residential property outlook
We are keen to differentiate here between the US and UK markets. We believe that the drop in US house prices has been sufficient to take them back to “fair value” (i.e. what is justified by the economic fundamentals). We forecast a slow recovery in prices over the medium term, but would not be surprised if prices “bounced along the bottom” for a while yet. In the UK, prices have not yet fallen back to “fair value”. Because of this, the recent recovery in UK residential property prices looks suspect in our view. The two charts below illustrate these points.
Chart 1: US residential house prices: actual vs. “fair value”
Chart 2: UK residential house prices: actual vs. “fair value”
Two other observations are of relevance here. First, one should place the most emphasis on analysis of the higher-quality official housing prices data, rather than being diverted by some of the private sector data series that may be narrower in focus. Second, we believe that the top end of the property market in the UK could continue to do better than the market as a whole, because, thanks to the fall of sterling, top-end property may now look cheap to a foreign investor (who has benefitted from sterling’s decline over the past year or so). But foreign investors in UK property should also be aware that they are taking a lot of currency risk, as a further fall in the value of sterling cannot be ruled out. An investor may want to hedge this position accordingly.
Commercial property outlook
We are keeping a close eye on trends in real estate investment trusts (REITs) – which are a leveraged form of equity investment. Accordingly, it is not surprising that these have roared back since troughing in early March. The US NAREIT series has risen by more than 70% between March and October – although it is still well shy of its previous peak.
Despite recent rises, we believe that both US and UK markets are still someway below their “fair values”, therefore we expect further gains in these two REITs markets in 2010, and believe that Europe and non-Japan Asia look good value too. (For further details, see the Real Estate section of the October edition of our quarterly publication.)
REITs are, of course, only one way to invest in commercial property. We also monitor and analyse the Investment Property Datanbank’s (IPD) commercial property series, which are designed to track underlying investment performance in the sector. The UK series appears to be something like 10% below “fair value" currently, as shown in the chart below. So, we are a little less optimistic on being long the IPD series than we are for REITs.
Chart 3: The UK IPD commercial property returns series
Formal modelling is difficult of one-off commercial property transactions – i.e. those outside of those covered by the liquid public investments in REITS or the Investment Property Databank (IPD) series. But we believe that there are opportunities here too for the careful investor.
In our most recent analysis of commercial property – in our latest edition of Compass – we focus on the UK market, arguing that there is scope for further gains in both rental and capital values.
These forecasts have the following implications, if they are correct. In the short term, overexposure to property in a portfolio may not matter: if our forecast is correct, and prices rise further, investors will make money. But this does not undermine the observation made above that many survey respondents look over-committed to property from a strategic perspective. Looking beyond the next quarter or two, we believe that investors ought to be using the opportunity to take profits on the more liquid and lower-transaction cost elements of their portfolio. We would like to stress the advantages of a tailored approach to portfolio management, with a clear distinction between short-term (tactical) and long-term (strategic) asset allocations.