Real estate: post-crisis boom draws to a close


When China’s Greenland Group launched its Spire project near Canary Wharf in east London in 2016, it promised the 67-storey residential skyscraper would be “a new iconic landmark on the London skyline”.

The £800m curved glass tower was set to include almost 800 luxury apartments, a 35th-floor spa, a cocktail bar, dancing fountains and lifts that would travel at six metres a second. But after piling works were completed a year ago, the Spire building site fell silent. 

The project is undergoing a “review” after “the residential sector in London . . . changed significantly since Spire London was conceived in 2014”, the developer said. The changes in prime London real estate have indeed been stark: prices have since fallen more than 20 per cent.

The developer insists the building will go ahead, though possibly in an altered form. But the stalled site has brought back memories of the financial crisis, when from Ireland to Dubai, half-finished construction projects conceived at the peak were stopped in their tracks by collapsing markets, a lack of funding or insolvent developers.

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The troubled development is one of many signs that the global real estate boom is drawing to a close after a decade of cheap money that followed the financial crisis. Stores are shuttering on New York’s Fifth Avenue as the retail sector suffers in the face of the relentless rise of ecommerce. In China, a frenzy of real estate speculation has led to millions of empty new-build apartments and to street protests over price drops. Listed real estate securities worldwide are trading at steep discounts to the book value of their assets, a phenomenon that in the past has heralded downturns.

Other parts of the market, such as offices in major cities, have remained healthy. But some respected figures are preparing for a broader slump. Sam Zell, the Chicago-based real estate billionaire known for his sell-off of a $36bn office portfolio on the eve of the financial crisis, has been selling again: he has disposed of almost all the properties within Equity Commonwealth, a $3.9bn real estate investment trust.

That process, he says, has brought home the market shift. “Four and a half years ago, when we put a property on the market, we had 17 bids, and 15 of them were real. Last year when we put one on the market, we had three bidders, and we hoped one was real,” he said. “It’s clear that in the commercial real estate world, no one is clear about what values are.”

Sam Zell, the Chicago-based real estate billionaire, says ‘there is too much capital chasing too few opportunities’ in the real estate market © Peter Wynn Thompson/FT

Eleven years have passed since the financial meltdown in which real estate played a starring role. Portfolios of toxic residential mortgages paralysed credit markets, while some $40bn of risky commercial real estate exposure helped to bring down Lehman Brothers.

Real estate markets around the world now look very different from those before the crisis. Debt levels are lower, mortgage regulation tighter and speculative building more modest. A huge influx of institutional capital has entered real estate, as quantitative easing bloated markets and narrowed bond yields, forcinginvestors to look elsewhere for income. With interest rates set to remain lower for longer than was thought likely a year ago — economists expect the US Federal Reserve to actually cut rates this year — that search for yield is set to continue.

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But that flow of cash has given rise to fears of a bubble. Real estate prices in global cities have soared to new highs: they are 45 per cent higher than at their previous peak in 2007, according to Real Capital Analytics. Yet vast sums are still pushing into the sector. Closed-ended real estate funds had raised a record $342bn of still-undeployed capital worldwide at the beginning of April, according to data from Preqin, of which $62bn was committed to debt funds — also a record.

Glass empty: work on the Spire, a 67-storey luxury block near Canary Wharf, London has stalled © Charlie Bibby/FT
Glass full: Billionaires’ Row, the set of ultra-luxury residential skyscrapers in Manhattan © Cynthia Van Elk/FT

“The real estate market has been ahead of itself. It’s been very much impacted by the fact that there is too much liquidity . . . There is too much capital chasing too few opportunities,” says Mr Zell.

Few observers believe the market faces an immediate crash. Chad Tredway, co-head of real estate banking in JPMorgan Chase’s commercial bank, says: “Everyone has been calling for a correction since 2014 or 2015 but nothing has really happened . . . I’m not feeling like from a pricing standpoint there are flashing red lights. I would tell you there definitely are yellow lights.”

But institutions’ exposure to real estate is on regulators’ radar. In its first financial stability report in November last year, the US Federal Reserve raised high commercial real estate prices as a key vulnerability.

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“We are in the more mature part of this cycle, particularly in the US, and pricing is high in many places,” says Lauren Hochfelder Silverman, managing director in Morgan Stanley’s real estate investment division. “We are finding interesting things to do but we are very disciplined and selective. We are very focused on downside protection.”

Mr Zell is one of a class of self-made real estate investors who drove much of the industry in the second half of the 20th and early 21st centuries. But they are becoming a rare breed. Property markets once dominated by maverick individuals are now home to trillions in pension and insurance capital, often managed by investment groups such as Blackstone and Brookfield. In 2007, Blackstone had real estate assets under management of $19.5bn; now it has more than seven times that. 

The inexorable rise of economies in Asia, meanwhile, has meant that sovereign wealth funds, pension funds and insurers from China, Singapore and elsewhere have been equally hungry for global real estate assets, snapping up huge portfolios such as Blackstone’s Logicor warehouse group, bought for €12.25bn by China Investment Corporation in 2017.

The Spire project was part of a surge of Chinese investment into western cities. At $90bn, global cross-border real estate investment from Asia exceeded that originating from North America or Europe for the first time in 2017, according to property agency Knight Frank. “The world has become smaller. It used to be much more parochial in terms of where people would invest equity and deploy debt,” says Jim McCaffrey, managing director at Eastdil, a US-based real estate investment bank.

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Doug Harmon, chairman of capital markets at UK property agency Cushman & Wakefield, says the “institutionalisation” of real estate means that “the game has changed”. He adds: “It has become a much more boring, disciplined sector, but the foundations are stronger.”

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But the influx of capital has also led to a desperation to deploy it. This has pushed up prices in unlikely corners of the market, from rented homes in Wilmington, Delaware to warehouses in the Czech Republic. Cash has flooded into “alternative” forms of real estate such as student housing, elderly accommodation and healthcare buildings. 

Some in the market suggest that investors have used over-optimistic projections of future rental growth to justify paying higher and higher prices. They may not be taking into account more efficient use of office and retail space, which means that even where economic growth is strong, some businesses are shrinking their footprints.

Mike Prew, an analyst at Jefferies in London, says: “Real estate assets have been pricing in a very high, above-trend rental growth rate in many sectors, especially offices.”

One US banker says they are shocked by prices on assets such as Shanghai office buildings, where rental yields — which compress as prices rise — are narrowing to levels similar to those found in London or New York, despite the city’s far younger and more volatile market. 

“I’m saying for the first time maybe since before the [crisis], maybe the market is sending me a signal . . . it’s the first time in a while I’ve taken a few steps back and said ‘I’m finding it hard to make sense of this’,” says the banker.

Lord & Taylor’s century-old flagship store closes on Fifth Avenue, Manhattan, in 2017 © AP
WeWork and Rhone Capital bought the Lord &Taylor building for $850m © Cynthia Van Elk/FT

When Lord & Taylor’s century-old flagship store on Fifth Avenue was designated a New York landmark in 2007, the city’s landmark preservation commission called it “a recognised innovator in the history of department stores”.

But the store was unable to innovate fast enough for the 21st century. In 2017, Hudson’s Bay, the owner of Lord & Taylor, announced it had agreed a deal to sell the Italian Renaissance-style building to the serviced office provider WeWork and its investment partner Rhone Capital for $850m, to help pay off Lord & Taylor’s debt. Instead of selling suits and jewellery, the building will soon be filled with casually-dressed millennials working on sofas, drinking beer and eating vegetarian food.

The largely debt-funded acquisition closed earlier this year, becoming a prime example of how the use of buildings is changing. Jeff DiModica, president of Starwood Property Trust, one of the lenders, called it “a really smart trade on a really beautiful building”.

But there are sceptics — including Mr Zell, who believes WeWork and its rivals are among some sections of the market that have attracted more cash than hard-headed scrutiny. “With the exception of retail there is pretty significant [tenant] demand but there is a question of whether that demand is as good as it looks,” he says. “WeWork would be an example . . . and it has spawned a lot of me-too competitors. They are taking space that previously was occupied by a tenant with credit.”

WeWork, which is working towards a public listing and has been heavily backed by Japan’s SoftBank, has transformed the market for office space by leasing smaller companies, and departments of large ones, fashionably decorated shared space on all-inclusive contracts. But these deals, and those offered by competitors such as Knotel, are short-term, raising questions over the stability of their sites.

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In an April report on the impact of flexible offices on commercial mortgage-backed securities, the rating agency Standard & Poor’s said: “Our overall credit view of co-working tenants, all else equal, is negative relative to traditional ones.”

WeWork and its rivals disagree. The company argues that more relationships with big corporates are strengthening its tenant base and a downturn could actually cause more firms to turn to its short-term deals. Advocates of the WeWork model point to shifts taking place across real estate: leases are shortening and tenants becoming more demanding of their landlords.

Still, a reversal of fortunes for the sector could sour sentiment in major office markets like London and Manhattan. In Manhattan, flexible office groups accounted for 18 per cent of new leasing in 2018, according to CBRE. 

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Mr Zell is not the only market player suggesting the capital influx has created bubbles with the potential to burst. Others see risks building in private debt, where lightly regulated and opaque debt funds have partially filled a vacuum left by banks’ post-crisis retreat from real estate lending. 

Debt funds are often backed by institutional investors or by credit lines from banks, who do not have to account for such lending as real estate loans. Lending by these funds helped to propel a boom in high-end residential construction, creating what many analysts now describe as an oversupply.

Josh Zegen, co-founder of the US real estate private equity firm Madison Realty Capital, says: “There may be a bubble in credit, and it’s not with the banks, but with the debt funds . . . We are already seeing cracks in the system, with loans not hitting their business plans.”

Matt Borstein, global head of commercial real estate at Deutsche Bank, says debt markets feel “frothy”. “Loan-to-value ratios have been really disciplined but there has been an aggressiveness in loan pricing which seems to know no bounds right now,” he adds. 

Some analysts argue that despite market risks, buildings like the Lord & Taylor flagship will hold their value for some time. The past three years have rewarded braver real estate investors: those who prepared for a steep downturn in 2016, when the market slackened, are now falling behind bolder rivals, since no crash materialised.

Yolande Barnes, chair of the Bartlett Real Estate Institute at University College London, says real estate markets are on a “high plateau” but low interest rates may lead to gentler cycles, and lower price inflation, in the future.

Still, Mr Zell continues to reduce his real estate exposure. Equity Commonwealth, for example, was sitting on more than $3bn of cash at the end of March, according to S&P Capital IQ.

“Any day you’re not selling, you’re buying,” Mr Zell says. “And I’ve got to face up to whatever position I take.”



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