The Return of Aggressive Pricing

By Peter Hobbs

Source: IPD

Source: IPD

The strong momentum over recent quarters suggests that 2014 will be another stellar year for real estate, the fifth consecutive year of above- average performance since the financial crisis. Although there tends to be a delay before most national markets report their year-end performance, the early results from the U.K., the U.S. and, particularly, Ireland confirm continued strong performance. The results for Ireland, at 40 percent for the year as a whole, are staggering, and represent the best-ever annual performance since the series began 30 years ago.

Despite this strong performance, concerns are increasingly being raised over its sustainability. On one hand, income returns, which tend to account for the largest component of real estate performance, have fallen sharply—from an annualized 7.7 percent at the end of 2009 to 5.9 percent at the end of 2014 in the U.K., and from 7 to 5.3 percent between mid-2010 and the end of 2014 in the U.S. On the other hand, these yields are down to levels not seen since 2007-8, the prior cyclical peak and a powerful signal of market pricing.

These trends are well illustrated by the pricing indicator for the four national markets of Canada, the U.S., the U.K. and Ireland. This indicator tracks the pricing of national markets based on two simple measures, income return and income-bond yield spread, over each of the past 10 years. As evidenced in the chart at right, most markets became aggressively priced during the 2007-8 peak and then corrected during the years of the crisis. Over recent years, pricing has become more aggressive, particularly in Canada and the U.S. Despite the surge in pricing in the U.K. (with values up by 12 percent in 2014) and, to a much greater degree, Ireland (30.7 percent in 2014), these markets do not seem as aggressively priced as Canada and the U.S.

Many investors take comfort in the relatively low levels of new supply and the still-attractive spreads with bond yields, and continue to aggressively bid for real estate assets. But many others are becoming more cautious, exploring opportunities to invest in less-favored markets—often overseas—or deciding to hold back until real estate itself becomes less frenzied.

—Peter Hobbs is managing director & head of research for IPD