Making and losing money in commercial property

Dubai - Have a look at the market's most fabulous opportunities

The sharp rise in US Treasury, British gilt, German Bund and other government bond yields is a disaster for real estate investment trusts (Reits) worldwide, including those in the GCC. In the $1.2 trillion US Reit market, prices of Reits investing in commercial property segments have fallen 20 to 30 per cent from their 2017 peaks. Take Equinix, the world's leading data centre Reit, one of the world's most profitable, high-growth property niches with such huge technological barriers to entry that only six firms dominate the market, a classic oligopolistic industry structure. Equinix shares have fallen 20 per cent from their recent highs. Shopping mall Reits have been gutted by lower mall traffic and Amazon's death star impact on online retail economics. In other property niches, such as self-storage and nursing homes, oversupply has added to low liquidity and higher financing costs to pressure share prices.
A rise in the risk-free government bond yield increases the cost of borrowing to buy commercial property as well as lessens the present value of its future rental cash flows. Since most REIT's cannot raise rental income from tenant leases at the same rate as the bond yields in capital markets, their profit margins compress. Bond yields will continue to rise as the Federal Reserve hikes its policy rate and shrinks its balance sheet amid an acceleration in synchronised global economic growth and higher US wage inflation.
Property investors definitely believe in the Philips Curve even in the age of Alexa, Echo, robotics and digital money. It is a grim mathematical reality that a rising cost of debt increases the cost of owning property and so triggers a fall in property values. This is as true of trophy-office buildings in New York's Manhattan or London's Canary Wharf as Dubai's JLT and Business Bay, where vacancy rates are above 40 per cent yet new supply continues to add to the glut in office space. Oversupply ensures a protracted fall in rents and capital values in a given property segment, even in markets with no banking credit crunch, affordability or demand shrinkage issues, as exist across the GCC.
Strangely enough, hotel Reits on Wall Street are a relative safe haven in times of higher interest rates since they can quickly respond to higher interest rates by immediately increasing room rental rates. Yet this is not possible in any market where oversupply glut forces down the average daily room rate and thus revenue per available room. Those selling offplan pieces of paper promising double-digit hotel "yields" will hemorrhage money as 50,000-60,000 new rooms thus financed finally hit a glutted market.
The most fabulous opportunities in commercial property investing emanates from falls in supply demand shocks or charges in government policy that benefit owners. So when the Saudi government announced plan to double Umrah pilgrims visas to 15 million in Vision 2030 and demolished/reclassified 25,000 rooms in the heart of the holy city of Makkah, I knew this would be the most profitable four-star hotel market in the Middle East on leased land in 2015 - and this is exactly what happened.
Brexit was nirvana for office space in Frankfurt, home of the ECB, the Bundesbank, Deutsche Bank and the German stock market. US banks, led by JPMorgan and Goldman Sachs, have scrambled to add space as they move hundreds of bankers from the City of London, as do Japanese banks. Ireland's banking system was kaput a decade ago but now Dublin is the hottest Brexit hedge in Europe as the EU's sole English speaking state. Limited office space supply but a surge in Brexit related demand from global banks means a surge in Dublin rents and deal ask prices.
A brilliant property developer/investor friend in Dubai took advantage of the Portuguese and Greek banking crash amid the Euro crises to snap up hotels and shopping complexes as low as 20 per cent of replacement value in 2012. When such systemic crises hit, brick-and-mortar construction shuts down. Yet as economic growth returns and credit markets stabilise, as happened in Lisbon and Athens when Mario Draghi fired his monetary bazooka and midwifed the EC/IMF bailouts, my Dubai friend tripled his capital. Ideas make money and liquidity is like a cab on a rainy night. It disappears when you need it the most. This was a lesson taught to me by a New York banker who died a century ago - J.P. Morgan, founder of the bank that changed the world and once changed my life.
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.