Impact of Global Financial Crises on UK and Role of Property Investment in Crises - Essay Example

?FINANCIAL & ASSET MANAGEMENT IN REAL E DEVELOPMENT 0- INTRODUCTION Investment is aimed for the return and stable return can only be achieved from a well diversified portfolio. With recent fluctuation in equity market investors has realized the importance of diversifying their portfolio with increased options than limited investment choices. One of the options that have increasingly being adopted is real estate based on the benefits it has offered in the past years. This change in market dynamics has moved individual investors to real estate investment along with institutional investors (IPF, 2007). However; alike all asset classes real estate investment avenues also have business cycle. Real estate investment generates attractive returns in one phase of business cycle while on contrary to this it may also be unable to fetch similar returns in other business phase. Therefore, in order to gain the real and timely benefit from real estate it is necessary to understand factors causing rise and fall in the real estate value. These attributes include, though not limited to: initial considerations, risks, valuations, structures, costs; respective returns etc. In addition to this, understanding related to these factors would lead to the pro-active measures undertaking that result improved returns. Hence, given below is the discussion related to various aspects of the real estate investment developing insightful information 2.0- COMMERCIAL PROPERTY INVESTMENT Commercial property investment refers to an investment in property for yielding return for its owner by being used or occupied by businesses (Reita, n.d.). In UK ?762bn of property is accounted as commercial as compare to ?3,400 billion of residential property and ?1,781 billion invested in equity market. Of this stated investment in commercial property 90% comprises of commercial property while almost half of this is lend to tenants for return. The composition of UK investor in commercial property is as follows: (Adair et. al, 2009) With increase in volatility of equity stock market, investors have increasingly moved to commercial property investment. Moreover, with investment in commercial property directly being difficult from knowledge, legal and capital aspects individual investors in UK have opted for residential investment and lend it for return (Adair et. al, 2009). 3.0- PERFORMANCE OF REAL ESTATE IN PAST FIVE YEARS 3.1- IMPACT OF GLOBAL FINANCIAL CRISES ON UK AND ROLE OF PROPERTY INVESTMENT IN CRISES Followed in the autumn 2007 the credit crunch crises that hit US market was rejected by many unless the impact became evident as global financial crises. UK and other European markets that rejected US credit crunch impact apparently ignored the down side of the risk that has been spread round the world by means of diversification (Anderson, and Timmons, 2007). Specifically in 2007, analysis of Bank of England related to comparison of UK real estate market and U.S. situation went unnoticed until the crises landed on door stop (Bourke, 2007). Also among various risks calculated for the property market, fact remained that investor (backing investment from bank loan) were not giving attention to down-side of the risk that is increasing fragility of various asset based product. To rush with multitude momentum growth, this risk was assumed to self reduce with rise in property prices in case borrower defaults (Adair et. al, 2009). Of the total 9 trillion in mortgage debt in US, 900 billion constituting sub-prime paper on world’s balance sheet infuriated the problem on global level (Adair et. al, 2009). Oswald (2009) referred to decline in housing market as one of the major causes along with decline in oil prices; contraction of bank lending and lost in investors’ confidence in financial institutions. It burst the perception bubble like that of dot-com that there is no fall to this rise. Moreover, UK among all victims of financial crises was hence predicted and found to be biggest victim following growth of -0.2% in 2008. 3.2- IMPACT ON UK COMMERCIAL PROPERTY MARKET Investment in UK commercial property market enjoyed robust growth with total return of 20.2% for almost 11 to 13 years since the collapse in 1993. Moreover, in the tenure of 1992-2006 this asset class remained the top performer against other asset classes especially in investment tenure of 3, 5, 10 and 15 years. These and other factors such long term investment of 15 years being the least volatile among asset classes attracted huge investment from individual planning for retirement (Adair et. al, 2009). (Adair et. al, 2009) Lending increased to finance the commercial property investment amounting to almost ?. 81.1 billion accounted only new approved loans in 2006. Overall loan amount for commercial property investment aggregated to 172.1 billion is excluding 18.2 billion of debt securities in CMBS market (Capital Economics, 2007). Given below figure refers to increase in loan amount from commercial banks and key lending institutes in property sector in the tenure of 2001-2006: Consistent rise in commercial property lending led to increase in investment in the speculative projects as below (Adair et. al, 2009): However, after consistent rise in commercial property that attracted considerable investment in UK market witnessed restrains in the beginning of 2007 and year 2008 recorded outflow. To mention ?.129 million of Irish investment was withdrawn in 2008 (Capital Economics, 2007). Constrains on lending to speculative projects in 2007-08 compounded problem of property sector with institutional lenders' withdrew from market. It was though in anticipation of valuation correction and but led to panic as investors were not ready to accept such correction. Correction led Investment Property Databank to post negative return first time since inceptions (Adair et. al, 2009). Market yielded total return in negative side from capital value decline despite income returns from commercial property remained in the positive domain (Adair et. al, 2009). Office sector was the biggest victim as the businesses were closing; retail sector led to very choosy selection with impact multiplied impact from shopping centres (Blackman, 2008). Finally, expectation of investment from Germany and Sovereign Wealth Funds also receded with former anticipated the economic contraction and latter received direct hit from market correction on Wall Street (Adair et. al, 2009). The resultant was financial innovation with banks selling off their property loans of ?.76.0 billion in 2010 for averting the increased impact from crises. 4.0- MECHANISM With fact that various asset classes have varying characteristics similarly within asset class product vary to provided investment avenue to wider range of investors. This obvious phenomenon is also applicable to real estate investment class and hence, considerable difference in commercial property and residential property exist. For instance, aspects like cost, term period, renew liability, type of return etc all these basic difference are reflected in the difference in boom time period of two products from similar asset class. 4.1- COMMERCIAL PROPERTY IVNESTMENT Commercial property asset class can be defined based on the following features: 4.1.1- CASH FLOW STABILITY AND SECURITY: Average period of income stream in the commercial lease property is 7.1 years in UK dependent upon the lease term; therefore fetching consistent returns. Also return from commercial property is mainly generated from income streams (against capital gains) such as in 2006 it generated 4.9% as compare to 3.2% from equities; hence it provides more secure and stable cash flows (IPF, 2007). (IPF, 2007) (IPF, 2007) 4.1.2- PERFORMANCE, LOW VOLATILITY AND DIVERTSIFICATION Commercial property investment also has the capability to outperform returns from equity and Gilts when valued for longer period of time. Also fact that makes property investment more attractive is attractive return with low volatility as compare to other asset classes (IPF, 2007). Based on the correlation with other assets investment in property increases overall diversification if the portfolio. (IPF, 2007) (IPF, 2007) (IPF, 2007) 4.1.3- OTHERS Other features making it’s different from other asset classes include tangibility that ensure value retained in contrast to other assets that are valued on paper without existence (except piece of paper). Revaluation of the asset and its respective income stream can also be increased with negotiation with other party as well taking multipurpose benefit from it (IPF, 2007). 4.2- MARKET MECHANIMS The market mechanism of the commercial investment has lease and ownership; buying and selling; valuation and market indices. Understanding of these aspects is important to ensure investment has been rightly invested (IPF, 2007). 4.2.1- Ownership and lease are more towards legal matters. It requires investor to investigate time, tenants; break down etc. Hence, it is more dependent on understanding and negotiation with tenants than market factors. 4.2.2- Buying and selling of property is very critical aspect to understand as it is driven privately has no public market aside of auctions. Hence, market makers are rested with almost all rights as agreed upon. 4.2.3- Cost and Liquidity: Each deal of property investment involves sizable cost and hence has to be considerate. This not only involves cost of product (property) but also at the same time requires investor to incur cost of legal fees of advisor, government charges such as land tax etc. Usually market in UK charges 1.7625% of property including VAT but this may increase based on the nature or more specifically the characteristics of property. This huge cost leads to less people directed to property investment and considering it less liquid investment. Also in case of investment made requires sizable return. However, increased activity in the property market has reduced the life of lease over years and decreased the liquidity constraint. 4.2.4- VALUATION: Most important component of the commercial property investment lies in valuation. Valuations of openly traded securities are often miscalculated therefore; chances of miss-valuation are present in multiple folds as properties are not traded on public markets. This does not mean that investors are left on mercy of advisor for investment. Guide book known as Red Book is available for guiding valuation of property. Moreover, authentic websites are available for the guiding such as REITA website (Real Estate Investment Trust Association) and other website provide investors information; facts and updates related to investment in property in particular area. Despite factors informed on these websites; still there remains that property market deals in imperfect market mechanism of economy and hence all information is not efficiently available to all. 4.2.5- BENCHMARK: since property is not traded in the open (public) market therefore valuation requires benchmark. Benchmark for property valuation is provided by the independent research organization in IPD (Investment Property Databank). Also FTSE Commercial Property Index is also providing investors’ benchmark with various aspects accounted with significant difference from that of IDP. Hence, investors much explore trend and important fluctuations with respect to property being considered for investment. 5.0- CONSIDERATION FOR SUCCESFUL INVESTMENT Factor that differentiates property investment from other asset classes also calls for the immense consideration before opting property for investment. Moreover, in case if investment is planned through fund or an institution therefore it requires to consider additional factor such as regulation applicable from the intermediary etc. On contrary to this, investment in the property directly is also big risk and requires more factors to account as stated above. Hence, only preplanned and well thought investment can reap desired return. For pro-active management, following are certain areas to be considered: Financial Services and Markets Act 2000 (FSMA) provides in detail for investor the regulatory aspect necessary to be considered before investing. Opting for suitable investment option such as funds that invests collective pool of individual investors’ money in property is very important. Such funds facilitate investment against certain management fee but ensure expert opinion in investment. IT also makes investment safer than it is in case of private investment activity. Moreover, units of these funds also facilitate small investors to share return of real estate with no capacity to invest directly in property. Various risks are prone to investment such as product; price, tax, location; sector market etc. Like every asset class real estate also has product life cycle in which product is not consumed but value does vary based on various aspects. Therefore requires investor to decide appetite for the risk. Investor must also account for the capacity to sustain against down side of risk in order to remain safe and doesn’t not fall caught in the trap where, for instance, market correction remains within acceptable domain and does not lead to panic. Apart from investment, commercial property invested when rented also requires for considerable attention to detail such as tenant’s credit worthiness; required return over the period of contract, break ups, negotiable aspects etc. Various domestic and off shore investment opportunities are available to investors. Selection of the avenue investment is channelized based on suitability of the avenue to investor. For instance, investment for pension funds if channelized through pension funds in real estate sector would facilitate investor with due tax benefit. Hence, planned investment with would ensure risk mitigated to greater extent, if not completely addressed. 6.0- FUTURE OF COMMERCIAL PROPERTY Since risk is an implied factor in every return; therefore, no investment shall be considered risk free that is to yield high returns. However, based on the current and past market conditions it is possible to make some baseline prediction though not accurate. Deloitte (2012) provides anticipation for year 2012. Since the year has passed in full therefore, basic ideas of prediction can be considered as a guide for future. Most important fact asserted is prediction that no matter worse considition characterizes the market; conditions always improve. It also suggest that when rise in market is attributed to high returns fall in the market shall also be welcomed for increasing participants in the market and hence again gaining momentum. Real estate investment shall continue to be taken as high return asset along with the implied characteristics of the asset class for long term. Primary and secondary real market will also continue to have cyclical growth with demand and supply rule applicable. Increased online retailing will continue to increase pressure on high streets and lending firms tightening their strategy. Hence, this tough time of the economy may show some more strict attempts to gear up the growth momentum. References Adair, A., Berry, J., Haran, M., Lloyd, G., and McGreal, S. (2009). ‘The Global Financial Crisis: Impact on Property Markets in the UK and Ireland’. University of Ulster Real Estate Initiative, Available from http://news.ulster.ac.uk/podcasts/ReiGlobalCrisis.pdf [Accessed 26 December 2012] Anderson, J. and Timmons, H. (2007). Why a US Sub-prime Crisis is Felt Around the World. The New York Times. Bourke, C. (2007). Feeling the Pinch. Estates Gazette. Capital Economics (2007). UK Commercial Property Market Monthly. Deloitte. (2012). Real Estate Predictions 2012: New Realities, new perspectives. Available from http://www.deloitte.com/assets/Dcom-Austria/Local%20Assets/Documents/Studien/uk-re-real-estate-predictions-2012.pdf [Accessed 26 December 2012] IPF. (2007). Understanding commercial property investment. Available from http://www.bpf.org.uk/en/files/reita/reita_org_documents/reita_guides_ifa_guide_May07.pdf [Accessed 26 December 2012] Oswald, A. (2009). We’re going back to work - but will we be sitting comfortably?. The Times. Reita. (n.d.). What is commercial property?. Available from http://www.bpf.org.uk/en/reita/about_property/what_is_commercial_property.php [Accessed 26 December 2012] Read More