Although the value of the real estate capital market continued to grow to reach US$12 trillion in 2007, the year witnessed a sea-change in the global investment environment, following what the International Monetary Fund has labelled ‘the largest financial shock since the Great Depression’.

Real estate has been at the heart of events, acting as both original trigger (US residential sub-prime) and an important transmission mechanism to the real economy (e.g. the UK mortgage and housing market). Globally, the commercial real estate market had in fact already peaked well before the sub-prime crisis broke last August. However, the market’s cyclical downturn has been greatly reinforced by a sharp tightening in the availability and pricing of debt and a widespread deterioration in market sentiment initiated by the sub-prime crisis.

The US and UK investment markets are more highly leveraged than those in Asia Pacific and Europe, so it is perhaps not surprising that they have been most directly exposed to problems in the debt markets, with tighter credit conditions exacerbating pressures on highly geared investors and bringing an end to yield compression. The correction in market pricing has occurred most rapidly in the UK, where yields have moved out by 12bps since their trough in April 2007.

Whilst the European market is lagging behind the downturn, sentiment in Asia Pacific remains relatively positive, as it is still supported by strong economic and occupier market fundamentals. Intra-regional trade is burgeoning and it is becoming more evident that the region has the potential to sustain growth without the kind of heavy reliance on the US that was a key feature in the past. With the possible exceptions of Japan, Australia and to a lesser extent Singapore, the impact of the credit crunch on the investment markets in the region has been fairly muted to date.

There have been tentative indications that the worst of the sub-prime crisis may be over, and the Fed in particular has cut interest rates aggressively to head off the threat of serious recession. However, the fundamental change in the investment environment which the sub-prime crisis triggered is likely to be long-standing and a quick reversion of investment market conditions to those prevailing before August 2007 is unrealistic. Credit conditions look set to remain tight for the foreseeable future, whilst falling asset prices are likely to prompt an inevitable period of adjustment in the US and UK economies following years in which consumer spending has been supported by realising asset price gains (notably in housing) and increasing debt.

This will provide a challenging environment for the real estate investor. Globally, the correction in yields still has some way to go (particularly on secondary assets) and investment transactions are likely to be sharply down this year, with capital flows set to follow. Relatively limited prospects for capital growth will make occupier market fundamentals (and effective asset management) critical to investment returns.

Nevertheless investment opportunities remain and are likely to grow as markets approach ‘fair value’ in the US and Europe, with equity-based investors in a particularly strong position to capitalise. Globally, investors are targeting the developing markets of Asia Pacific, reflecting a still buoyant occupier market outlook and improving access.

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