Anticipating Real Estate Capital Markets Downturns€¦ · to the economy, real estate markets, and capital markets. This paper expands the note on tracking and more importantly anticipating

Anticipating RealEstate Capital MarketsDownturns

Authors and Contributors:

Jacques GordonGlobal [email protected]

Paul GuestHead of Asia-Pacific Strategy, [email protected]

Richard KleinmanManaging Director, [email protected]

Bill MaherHead of North America Strategy, [email protected]

Mahdi MokraneHead of European Strategy, [email protected]

LaSalle Research & StrategyAugust 2015

LaSalle’s 2015 Investment StrategyAnnual (ISA) focuses closely on cycles;we delineate the different cycles thatimpact real estate (RE) returns, estimatewhere we are in those cycles, andpropose strategic and tactical actions to take in response. The three mostimportant cycles that we analyze relate to the economy, real estate markets, and capital markets.

This paper expands the note on trackingand more importantly anticipating capitalmarkets in Chapter 4 of the 2015 ISA. We discuss the importance of capitalmarkets for real estate investing, identifytools and techniques for tracking capitalmarkets across the globe, and provide asimple framework for collating the bestleading indications of the next turningpoint in the current cycle in the threeregions where we are most active: North America, Europe, and Asia-Pacific.

Real estate capital markets are notoriousfor “animal spirits” driving booms that run for years followed by sudden busts. A recent report from the World EconomicForum (WEF) on this topic highlights howchallenging it can be for governments,regulators, central banks, and privatemarket participants to predict and managethe real estate downturns1. The WEFreport highlights areas to look for signalsbut does not fully provide the guidelinesand tools to help anticipate a real estatedownturn, which is the focus of this paper.

Capital markets data is also generally very noisy. A 3% decline in stock prices or a 20bps increase in interest rates could be the first sign of an inflectionpoint, or it could simply be reversed thenext day. Separating signals from noise ischallenging both for high frequency publicmarket data as well as less frequentprivate real estate market information.

Key Points

1. Emerging Horizons in Real Estate. An Industry Initiativeon Asset Price Dynamics, Profiles, Prescriptions andProposals, World Economic Forum, January 2015.

LASALLE INVESTMENT MANAGEMENT | RESEARCH & STRATEGY ANTICIPATING REAL ESTATE CAPITAL MARKETS DOWNTURNS | 3

Anticipating Real EstateCapital Markets Downturns

After reviewing prior studies and testingpotential indicators for their ability to trackmarkets and anticipate changes in marketconditions, we identify three key areas thatare likely to provide advance signals:

1. Real estate supply / demand: Whatare likely future economic conditionsand how do they affect demand forreal estate? What are real estateoccupancy rates and the level ofsupply response?

2. Debt / Equity flows and terms:Is bank lending conservative oraggressive? Are banks still in goodhealth? Is securitization (CMBS,RMBS, etc.) contributing to the debt/equity imbalance? Are loans beingrepaid in a timely manner?

3. Real estate’s pricing relative to thecapital markets: Is real estate fairlypriced relative to Government andcorporate bonds? Are REITsoverpriced relative to stocks? Whatis REIT pricing telling us aboutpublic market views of real estate?

By monitoring these indicators, we cangenerate advance warnings signals thathelp predict market turning points. It isimportant to look at these indicators intotality. A single imbalance may notwarrant strategic reaction, but multipleimbalances could indicate a highprobability of a market correction ordownturn.

We provide a simpleframework for collating thebest leading indicators ofthe Capital Market cycle.


LaSalle analyzed a range of indicatorsfrom public and private real estate markets,debt and equity markets, other assetclasses, and the economy. A summary ofwhat we believe are the most powerfulmetrics is presented in Table 1, and amore complete description of theseindicators and how to use them isincluded further below.

As shown in the Table above, we havefocused on the most meaningful metricsfrom different categories. Within eachmetric, we also developed different levels of potential imbalance: a caution sign anda danger sign. The direction of change isalso important; 3 LaSalle InvestmentManagement | Research & Strategy anindicator in the caution range might beworrying, but could also be a sign ofcomfort if it was recently in the dangerzone. Importantly, we recognize that carefultracking of potential warning signs willrarely provide an unambiguous advancedsignal of a turning point. Clear, objectiveconsideration and analysis of the data andmarket context is still needed beforeactionable conclusions should be drawn.

LaSalle’s Dashboard for Tracking Real Estate Downturn Signals by Region

North America (US Focus) Europe (UK Focus) Asia Pacific

Real estate supply/demand • Leading economicindicators

• US Yield Curve

• Leading economicindicators

• Speculativeconstruction

• Corporate bondspreads

• Leading EconomicIndicators

• Yield Curve in matureeconomies

Debt/Equity Flows and Levels • CMBS Issuance

• Transaction volumechange

• Maximum LTVs• Bank default risk• RE debt as a % ofbank’s balance sheets

• Bank lending to realestate

• Transaction VolumeChange

Real estate relative pricing • RE yield spread tocorporate Bonds

• Trailing 6 month REITprices

• RE yield vs bonds• REITs vs stocks• Abnormal growth incapital values

• RE yield spread vsbonds & stocks

• REITs prices


North America Capital Market Indicators

• Real estate supply/demand imbalance° Leading Economic indicators – Thisis a basket of economic indicatorsdesigned to predict future economicconditions, including downturns. A two month decline in this indexindicates a cautionary note for realestate fundamentals and capitalmarkets, while four months of decline is a danger sign.

° Yield Curve – The yield curve hasbeen a reliable indicator of economicrisk, which often drives negative capitalmarket conditions. A negative spreadbetween the 10 year note and the 3month bill is a good indicator of futureGDP declines.

• Debt/Equity imbalance° CMBS Issuance – CommercialMortgage Backed Securities are one of the major avenues for debtfinancing for real estate. Issuance of CMBS bonds responds quickly to investor sentiment. We track thechange in trailing 3 month issuance,with two consecutive months ofdeclines indicating caution.

° Real Estate Transaction VolumeGrowth – The year on year change in the trailing three month transactionvolume is a good indicator of investorsentiment. One month of declineindicates caution while two consecutivemonths of decline or a 10% declineindicates a danger signal.

• Real estate relative pricing imbalance° Pricing Relative to Corporate Bonds–Baa Corporate bonds have a similarrisk profile to core real estate incomerisk. The spread between the trailingNCREIF income yield and the Baayield is a good indicator of relativepricing. A negative spread (real estateyields lower than bond yields) hasreliably preceded real estatedownturns, but sometimes precedesthe downturn by several years.

° REIT Pricing – A 10% decline inthe trailing 6 month trailing averageindicates a significant shift in investorexpectations regarding commercial realestate and a likely downturn in privatereal estate values.

We have identified indicators for the US and Canada, both of which have broad and deep historical data. The following discussion focuses on the indicators for the US,as it is the largest and most important market for global real estate investors.


US Capital Market Indicators

Goal: Monitor leading indicators of capital market inflection points

= Positive:Headed in the rightdirection minimal concern

= Caution:Merits added scrutiny

= Danger:Clear signal of potentialdisruption or downturn

Currently: 6 out of 6 indicators are Positive

= Real Estate Transaction Volume Growth

= Yield Spreads to Baa Corporate Bonds

= Trailing 6-Month REIT Prices

= CMBS Issuance

= Yield Curve

= Leading Economic Indicators Index

But historically low interest rates meancapital markets could shift quickly

Key Capital Markets Indicators Dashboard

As of 22 January 2015

Current signals suggestcapital markets are mid-cycle in the US.

Caption


Charts A & B: Capital Markets Indicators Transaction Volumes Healthy, NPI Income Spread to Baa Above Historic Average

A: Capital Markets Indicators Transaction Volumes Healthy, NPI Income Spread to Baa Above Historic Avg.

Source: Real Capital Analytics, NCREIF, Bloomberg

Mar

02

Oct

02

May

03

Dec

03

Jul 0

4

Feb

05

Sep

05

Apr

06

Nov

06

Jun

07

Jan

08

Aug

08

Mar

09

Oct

09

May

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Dec

10

Jul 1

1

Feb

12

Sep

12

Apr

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Nov

13

Jun

14

Y/Y

Cha

nge

of 3

-Mon

th A

vg. (

%)

As of 23 January 2015

-100

-50

0

50

100

150

200

B: NCREIF Income Yield Spread to Corp. Baa

Source: Real Capital Analytics, NCREIF, Bloomberg

1998 2000 2002 2004 2006 2008 2010 2012 2014

Yie

ld (

%)

Spread (bps)

NPI Income YieldSpread Baa Corp. Yield

3

5

8

4

7

6

9

10

-400

-300

-200

0

100

-100

200

300As of 23 January 2015

Avg. Spread: 29 bps

The year-over-year growth in real estate transaction volumes, shown above on a trailing3-month basis, has slowed from the dramatic rebound in 2010-2011. It remains modestlypositive, consistent with capital markets that are mid-cycle.

Current Signal: Positive. Monthly volumes are in-line with 2005 volumes, and still belowhighs reached in 2007.

The spread of 3Q trailing-year NPI income yields to Baa corporate bond yields was 67bps as of December 31, 2014. This is above 15-year average spread of 29 bps, leavingroom for compression of the spread in the event that interest rates move up.

Current Signal: Positive. However, interest rates are historically low and a rapid upwardmovement in rates could impact real estate values.


Charts C & D: Capital Markets Indicators REIT Prices and CMBS Issuance on Upward Trend

US REIT prices have historically been a leading indicator of private markets. This is a volatile indicator, influenced by interest rate movements, and the modest dips in the 6-month moving average in late 2011 and 2013 did not translate into a property marketdownturn. A decline greater than 10% would signal a shift in the market.

Current Signal: Positive. Prices have already recovered after a 6.5% decline in September.

Debt remains available from a variety of sources, including CMBS. Issuance slowed in October and November, but jumped in December. Some buyers report that the qualityof collateral has declined in recent issuance.

Current Signal: Positive. The market is active but it remains a fraction of pre-recession levels.

C: US Equity REIT Prices

Source: Bloomberg, CMA Alert

Aug

05

Jan

06

Jun

06

Nov

06

Apr

07

Sep

07

Feb

08

Jul 0

8

Dec

08

May

09

Oct

09

Mar

10

Aug

10

Jan

11

Jun

11

Nov

11

Apr

12

Sep

12

Feb

13

Jul 1

3

Dec

13

May

14

Oct

14

Yie

ld (

%)

250

850

650

450

-21.7%

-6.3%

-6.5%

6-Month Moving Average-54.6%

1,050

1,250 As of 23 January 2015

D: CMBS Issuance, 3-Month Trailing Avg.

Source: Bloomberg, CMA Alert

Mar

06

Aug

06

Jan

07

Jun

07

Nov

07

Apr

08

Sep

08

Feb

09

Jul 0

9

Dec

09

May

10

Oct

10

Mar

11

Aug

11

Jan

12

Jun

12

Nov

12

Apr

13

Sep

13

Feb

14

Jul 1

4

Dec

14

Insu

ranc

e $B

N

0

24

20

15

10

5

30

35 As of 23 January 2015


Charts E & F: Leading Economic Indicators Yield Curve and Other Leading Indicators are Positive

All six recessions since 1968 have been preceded by at least 3 consecutive months ofnegative spreads (average yields for the month) in the 12 months before the start of therecessions. During this same period, this measure has produced no false positives.

Current Signal: Positive. Spreads have been consistently positive since mid-2006.

The Leading Economic Indicators Index (LEI) is a composite economic index of 10leading economic indicators. It is constructed to summarize and reveal turning points inthe business cycle while removing the volatility of individual indicators.

Current Signal: Positive. It has been positive or stable 20 of the past 21 months.

E: Yield Spreads of 10Y to 3-Month Treasuries

Source: Bloomberg, The Conference Board

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Spr

ead

(bps

)

0

-200

-300

-400

400

300

200

100

-100


F: Leading Economic Indicators Index

Source: Bloomberg, The Conference Board

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Inde

x, 2

004

= 1

00

60

110

100

90

80

70

120



European Capital Market Indicators

• Real estate supply/demand imbalance° Leading Economic indicators – TheComposite PMI index has historicallybeen a good predictor of UK GDPrecession risk. During the lastrecession this indicator provided aclear signal in late 2007.

° BBB Corporate health check – Weuse corporate bond spreads: this is thespread of BBB corporate bond yields tothat of AAA rated companies. Thismetric captures the ability of theaverage UK corporate to accessaffordable credit and make real estateoccupancy decisions. During theprevious crisis this delivered a clear risksignal as early as September 2007.

° Oversupply risk – This is a pure realestate signal. Here we track andmonitor the extent of speculativecompletions in London as a warningsign of an overheating market. Overthe past three cycles, a marketdownturn followed immediately after aperiod where speculativedevelopments have exceeded the longrun average for 18-24 months.

• Debt/Equity Imbalance° Over stretched Loan to Value (LTV)Ratios – Maximum loan to value ratiosfor core property are used to measurewhether lending conditions havebecome too lax. LTV levels tend toincrease with overall marketconfidence and lender competition.Pre-GFC it was not uncommon forthese levels to reach 80-90% in manyEuropean markets. LTV levels above80% are considered warning signs.

° Banking system’s exposure to CREloans - The overall exposure of the UKbanking system to commercial propertyloans is a good indicator of anoverheating market if banks’ exposuresurpass the 9-10% mark (it reached9% in 1991 and 10% in 2005). Thecurrent reading of this ratio is 8.8%.

° Bank default risk – Traded CreditDefault Swaps (CDS) have proven tobe good indicators of bank stress andpredictors of distress and credittightening. A significant and persistentspike such as the one witnessed inJuly 2007 is a useful early indicator.

• Real estate relative pricing imbalance° Real estate yields spread togovernment bonds – This metric is thedifference between average UK propertyyields and the 10-year Gilt yield. Aspread falling durably below its long termaverage of 190bps calls for caution.

° REITs versus equities (REITsDividend vs Stocks’ yield spread). A negative spread between UK REITand UK equities dividend yields(normally positive) is a signal thatREITs may be overheating. During thelast downturn this signal set off alarmbells throughout the year 2007 as thespread thinned towards zero and eventurned negative in March 2008.

° Three-year IPD Real Capital Growth:This is signal is somewhat chartist inits approach but over the past threecycles in the UK (i.e. since 1971) twoor three successive years of 6%+ realcapital appreciation at an all-propertylevel in the UK has systematically ledto a market correction. For the timebeing we have one such year: 2014with an 11% real capital growth.

Europe is a large region with diverse real estate markets. The UK capital market cyclehas reliably been 6 to 12 months ahead of other European markets. Rather than focussimultaneously on all European countries, we advocate tracking the UK economy andmarket, given the depth and long dated time series as well as the maturity and liquidity of its markets. However, it is perfectly feasible to extend the signals discussed below toother European markets.


Illustrations for Europe

Goal: Monitor leading indicators of capital market inflection points (UK focused here)

LaSalle Risk Dashboard*: Capital Markets in Check

Supply/Demand Imbalance. Concerns over economic outlook not reflected in construction levels

*We use a variety of indicators with many in the UK as the regional leading indicator. We monitor three marketimbalances. Any two in “Danger” zone implies imminent (6-12 months) downturn

Source: LaSalle (12/14)

Debt/EquityImbalance

LTVs

Bank Exposuretoi CRE loans

Bank CDSspreads

Supply/DemandImbalance

Oversupply Risk

Recession Risk

Corporate BondSpreads

PricingImbalance

Rela Estate vs.Gilts

REITS vs.Equities

3yr IPD RealCapital Growth

Nov 13 Nov 14May 14

UK Corporate Bond Spread (%). Watch for: Rising yield gap

Source: JLL/LaSalle (10/14)/OECD/DataStream

Nov 04 Nov 06 Nov 08 Nov 10 Nov 12 Nov 14

Yie

ld (

%)

BBBSpread

125b

ps

AAA

0

4

2

6

8

Avg 10 YearSpread: 140bps

London/Se Office Completions (000 sq M)Watch for: Overall completion levels as well as % specs

2000

2002

2004

2006

2008

2010

2012

2014

2001

2003

2005

2007

2009

2011

2013

2015

2016

Speculative %Speculative

0

400

200

800

600

1,000

0%

40%

20%

80%

60%

100%

UK Economy Lead Indicator - Composite PMI Watch for: sustained fall in sentiment

Nov

06

Nov

07

Nov

08

Nov

09

Nov

10

Nov

11

Nov

12

Nov

13

Nov

14

Quarterly GDP GrowthComposite PMI (3 month avg)

35

40

50

45

60

55

65

-2.0%

0.0%

-0.5%

-1.0%

-1.5%

1.0%

0.5%

1.5%

}


Debt/Equity Imbalance. Stability returning to lending conditions but LTVs rising

UK Corporate Bond Spread (%). Watch for: Rising yield gap

Source: Bank of England, Capital Economics/DeMontfort UK Commercial Property Lending Market Year-End 2013 (2014)/Bloomberg/LaSalle

May

04

May

04

May

05

May

05

May

06

May

06

May

07

May

07

May

08

May

08

May

09

May

09

May

10

May

10

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11

May

11

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12

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12

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13

May

13

May

14

May

14

Jan

14

Mar

14

May

14

Jun

14

Sep

14

Nov

14

Yie

ld (

%)

Barclays Bank PLCHSBC Bank PLC

Commerzbank AGBNP Paribas SA

Banco Santander SAUniCredit SpA

0

4

2

6

8

Maximum loan-to-value ratios availableWatch for: Rising LTVs

Mar

14

May

14

Jul 1

4

Sep

14

Nov

14

Loan

-to-

valu

e ra

tio (

%) France Spain UKGermany

50

65

60

55

75

70

80

Lending to commercial property in the UKWatch for: % of total loanbook reaching 10%

1989

1994

1999

2004

2009

2014

Net new lending to property, £bn (RHS)

Lending to property as %of total loan book (LHS)

0%

2%

4%

8%

6%

12%

10%

14%

-£8bn

£0bn

-£4bn

£8bn

£4bn

£12bn

UK Yield Spread vs Government Bonds (%). Watch for: Yield gap falling below historic average

Source: Bloomberg/IPD/ONS/DataStream

Nov

87

Nov

90

Nov

93

Nov

96

Nov

99

Nov

02

Nov

02

Nov

05

Nov

08

Nov

11

Nov

14

Nov

13

Mar

14

Jul 1

4

Nov

14

Avg 34 year Spread: 193bps

-4-2

6

2

10

14

4

0

8

12

Spread between UK REIT Dividend Yields and Equities (%)Watch for: Sudden inflection in spread

Nov

04

Nov

05

Nov

06

Nov

07

Nov

08

Nov

09

Nov

10

Nov

11

Nov

12

Nov

13

Nov

14

FranceUK

4

0

2

-2

Property Correction Trigger: UK Real CapitalGrowth (%) Watch for: Two consecutive years of 6%+ Real Capitla Growth

1971

1977

1983

1989

1995

2001

2007

2013

-40

-30

-20

-10

10

0

20

Spread UK Government Bond IPD Yield

426b

ps}

Pricing Imbalance Scope for further yield compression

Caption


Selection of Two Key Indicators for Europe20

00

2002

2004

2006

2018

2010

2012

2001

2003

2005

2007

2019

2011

2013

2014

2015

2016

Speculative %Speculative

London/SE Office Completions (000sqm)Watch for: Overall completion levels as well as % spec

Sources: IPD

0

600

400

200

800

1,000

Property Correction Trigger: UK Real Capital Growth (%)Watch for: two consecutive yrs of 6%+ real capital growth

Sources: IPD

1971

1977

1983

1989

1995

2001

2007

2013

Inde

x, lo

ng te

rm tr

end

= 1

00

-40

-30

0

-10

-20

10

20


Asia Pacific Capital Market Indicators

• Real estate supply/demand imbalance° Leading Economic indicators –The Composite Leading IndicatorsIndex (CLI) is designed to provideearly signals of turning points inbusiness cycles by comparing currenteconomic momentum to long-termtrends. These indices, calculated bythe OECD, are some of the longestavailable time series of monthlyeconomic data for Asia, and allowcomparison to previous downturns in 2009, 2001, 1998, and 1990. Thewarning threshold is when the index is below long-term trend and falling.

° Yield Curve – In mature economies,short-term rates that are higher thanlongterm rates are a good indicator ofimminent economic recession. Thisindicator is less reliable for emerging orstate-directed economies such as China.

• Debt/Equity imbalance° Bank Lending to Real Estate –Historically, growth in lending hasnearly always been a medium- to long-term precursor to property sectoroverheating and correction. Heighteneddebt flows can last for several yearsprior to any turning point. We monitorfor consecutive quarters with rates ofgrowth comparable to the 2006-06boom, that is in excess of 15% y/y inChina or Australia or 5% in Japan.

° Real Estate Transaction VolumeGrowth – There is limited dataavailable on a national basis prior tothe GFC outside of Australia andChina’s evolving and non-transparent

land transaction driven market isdifficult to assess historically. Largedeclines in monthly transactionvolumes could be potential warningsigns of emerging stress in a market.

• Real estate relative pricing imbalance° REIT Pricing – The REIT markets inAustralia and Japan are deep andliquid, though their volatility is linked tobroader equity markets. Furthermore,the externally managed sponsorstructure in Japan can be distortive tovalue relative to fundaments. Chinahas not yet passed REIT legislation,but Hong Kong and Singapore havelisted REITs with exclusively Chineseexposure. These can be tracked as aproxy. For ease of comparison wehave adopted a similar measure to theUS: a trailing 6 month price changeand a 10% decline threshold.

° Real Estate Pricing Relative toCorporate Bonds – For each marketwe have sought to use a cap ratebased on in-pace NOI, though sourcesdiffer. For Australia and Japan, we usethe IPD All Property Index while Chinayields are based on the ShanghaiOverall CBD Office Index. This is thencompared to a low investment gradebond yield index, sourced from Bank of America Merrill Lynch. The depth of country’s corporate bond marketsdiffer – China’s is just emerging. Thecomparison threshold is the long termaverage, but this also varies due to dataavailability: Australia from 1996, Japanfrom 2002, and China from 2004+.

The economies and financial markets of the Asia Pacific region, while closely linked, arealso heterogeneous and at different stages of evolution. While similar drivers such asdebt, credit spreads, and REIT pricing are reputed as valuable leading indicators, there isno single set of financial markets data that are fit for all purposes. Furthermore, whiledata transparency and availability is rapidly improving, time series for many indicators arestill relatively short, covering at best two real estate cycles. The exception is Australia,where long time series permit meaningful cyclical analysis. Nevertheless, we have soughtto track a suite of indicators for Australia, China, and Japan that are indicative of turningpoints in financial markets and are roughly comparable to what is tracked elsewhere. Thesources and perhaps the indicators themselves will change as data availability improvesand local capital markets deepen and broaden.


Goal: Monitor leading indicators of capital market inflection points

= Positive:Headed in the rightdirection minimal concern

= Caution:Merits added scrutiny

= Danger:Clear signal of potentialdisruption or downturn

Currently: 6 out of 6 indicators are Positive

= Real Estate Transaction Volume Growth

= Yield Spreads to Baa Corporate Bonds

= Trailing 6-Month REIT Prices

= CMBS Issuance

= Yield Curve

= Lading Economic Indicators Index

Currently: CHN requires Caution, while AUS is Positive. JPN is currenltyPositive, but many many indicators are borderline and could shift.

Key Capital Markets Indicators Dashboard

As of December 2014

Volatile markets pointto correction in China,while Japan is stablebut at risk.


Charts G & H: Capital Markets Indicators AUS and JPN trending positive; CHN requires monitoring

The year-over-year growth in real estate transaction volumes, shown at left on a trailing 3-month basis varies by country. CHN is in reverse, while JPN and AUS are accelerating.Volume growth is below the boom of 2009.

Current Signal: Mixed. Monthly volumes in China are falling rapidly, while the reverse istrue in Japan

In Q3, the spread of cap rates to corporate bond yields in AUS was 298bps and in JPN457bps, the former well above its long term average and the latter in line. In CHN, thespread for Shanghai office income yields was -159bps, well below its long-term average.A short time series and single city/sector diminishes the impact of this variable.

Current Signal: Positive. Though CHN needs monitoring. Also, interests rates arehistorically low and a rapid move up could impact real estate values.

Real Estate Transaction Volume Change (3mma % y/y)

Sources: Real Capital Analytics, Bank of America Merrill Lynch, IPD, ARES, LaSalle Investment Management (LaSalle) As of December 2014

Mar

08

Sep

08

Mar

09

Sep

09

Mar

10

Sep

10

Mar

11

Sep

11

Mar

12

Sep

12

Mar

13

Sep

13

Mar

14

Sep

14

-200

200

0

400

600

Australia China Japan

All Property Cap Rate Spreads* to Corporate Bonds (bps)

*in each case we have sought to use a cap rate based on in-pace NOI, though sources differ. Australia and Japan�are All Property while China is specifically Shanghai Overall CBD Office. Also, time series differ, Japan (2002+) ,�Australia (1996+), and China (2004+)�

Sources: Real Capital Analytics, Bank of America Merrill Lynch, IPD, ARES, LaSalle Investment Management (LaSalle) (as of December 2014)

Q1

2003

Q1

2005

Q1

2007

Q1

2009

Q1

2011

Q1

2013

-400

-200

200

0

400

600 Historic average*Australia China Japan


Charts I & J: Capital Markets Indicators REIT prices are positive, but lending is picking upespecially in CHN

REIT prices have historically been a leading indicator of private markets, though theirhistory in Asia outside of Australia is limited. Signals are not unequivocal; e.g. the 2013decline in prices in CHN did signal a market downturn, but JPN’s contemporaneousdecline in REIT prices did not.

Current Signal: Positive. Prices are trending up in AUS and JPN, and are stable for CHN.

Lending to real estate remains readily available through a variety of channels, with banksincreasingly competitive across the region.

Current Signal: Mixed. In AUS and JPN, lending growth is up but is still less than halfthe rate of the 2007/08 boom. In CHN, the quantum of debt is a major worry. And,although the rate of gain slowed in 2012, it has re-accelerated in 2014.


Notes: created by LaSalle using price indices for Hong Kong and Singapore-listed REITs with 100% exposure to China

Sources: Bloomberg, CEIC, Bank of Japan, Reserve Bank of Australia, Australian Prudential Regulation Authority, LaSalle. As of December 2014

Mar

10

May

10

Jul 1

0

Sep

10

Nov

10

Jan

11

Mar

11

May

11

Jul 1

1

Sep

11

Nov

11

Jan

12

Mar

12

May

12

Jul 1

2

Sep

12

Nov

12

Jan

13

Mar

13

May

13

Jul 1

3

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13

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14

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14

Jul 1

4

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14

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14

50

70

90

150

130

110

170

190 ASX 200 - REITs

China REIT Index*

TSE REIT

AUS 200 day mva

CHN 200 day mva

JPN 200 day mva

Australia China Japan


Sources: Bloomberg, CEIC, Bank of Japan, Reserve Bank of Australia, Australian Prudential Regulation Authority, LaSalle. As of December 2014

Mar

05

Jun

06

Sep

07

Dec

08

Mar

10

Jun

11

Sep

12

Dec

13

Inde

x, lo

cal c

urre

ncy,

Q1

2005

= 1

00

0

100

200

300

600

500

400

700

800


Charts K & L: Leading Economic Indicators Mixed – yield spreads are positive but otherindicators are soft

In mature economies a period where short-term rates are higher than long-term rates is agood indicator of imminent economic recession. This indicator is less reliable foremerging or state-directed economies such as China.

Current Signal: Positive. Spreads for AUS and JPN have been consistently positive since2012. However, JPN’s yield curve is distorted by BoJ Quantitative Easing and could bemisleading.

The Composite Leading Indicators Index (CLI) is designed to provide early signals ofturning points in business cycles by comparing current economic momentum to longtermtrends.

Current Signal: Caution. All major economies are below long-term trend; however,while AUS and CHN are recovering momentum, JPN is still trending downward.

Yield Spreads of 10Y to 3-Month Government Securities

Source: Bloomberg, OECD. As of December

2002

2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

2009

2010

2010

2011

2011

2012

2012

2013

2013

2014

2014

Spr

ead

(bps

)

-200

-300

-400

-100

0

300

200

100

400

500 Australia China Japan

Leading Economic Indicators Index

Sources: Bloomberg, OECD (as of December)

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Inde

x, lo

ng te

rm tr

end

= 1

00

94

100

98

96

102

104 Australia China Japan

LASALLE

Conclusion

Overall there are a few conclusions to bedrawn from tracking and trying to predictcapital markets swings:

• Identifying reliable signals for capitalmarkets and calibrating the appropriatethresholds for what is considered ‘risky’versus ‘normal’ is not an exact science.Historical analysis shows that the triggerfor the repricing of risk differs nearlyevery cycle, meaning that anunequivocal ‘sell’ signal is unlikely for anilliquid asset class such as real estate.

• We also acknowledge that even if thesetools can predict the cycle inflectionpoint correctly and sufficiently well inadvance, it can be difficult to execute amajor portfolio adjustment given therelatively illiquidity of real estate.Indeed, building a high quality realestate portfolio often takes many yearsand a wholesale exiting of that portfoliocan be counter-productive.

• However, for real estate investors thesesignals can help position portfoliosdefensively early enough in the cycle, byselling weak assets early in anoverheating market, avoiding highleveraged positions, and focusing onhigh quality assets which traditionallyperform well in market downturns.

As we start 2015, we are carefullywatching for signs of changes in the realestate market. As of Q1 2015, our signalsare still globally “green” -- we are notseeing signs of a major downturn ormarket correction in any of the threeregions we monitor. As discussed, for corebenchmark driven investors, early warningsignals would provide the opportunity toshift portfolios to a more defensiveorientation by scaling back various riskpositions, reducing leverage, and sellingweaker assets. For closed–end funds andother absolute return strategies, warningindicators can be both buy and sellsignals, and could have an outsizedimpact on risk-adjusted returns as timingis central to fund/portfolio performance.

The dramatic collapse of credit marketsduring the 2007-2009 Global FinancialCrisis also plays a big role in our thinking.To summarize these lessons:

1. Capital markets around the world areinterconnected. Systemic risks canoccur when poor credit decisions inone country affect the investmentportfolios of financial institutions indistant countries.

2. Financial innovation outstripsregulators’ ability to track andmanage new financial products.

3. Intermediary behavior (originate todistribute) creates mis-alignmentsbetween the creators of financialproducts and the investors in theseproducts.

4. Rating agencies and securitiesanalysts are also under constantpressure to support these financialinnovations, rather than to beskeptical or critical of them.

5. The speed of trading in the securitiesmarkets and the currency marketstoday is unlike that of any previousera in financial history. Transmissionof crises from one market to anotherand other “contagion” effects arepresent in the capital markets to adegree that adds volatility andunpredictability to already-volatilecapital markets tendencies.

Important NoticeThis information is intended to assist professional investors in deciding whether they wish to consider the investment further. Thispublication does not constitute an offer to sell, or the solicitation of an offer to buy, any securities or any interests in investment fundssponsored by, or the advisory services of, LaSalle Investment Management and is subject to correction, completion and amendmentwithout notice. Any such offer, if made, will only be made by means of a confidential prospectus. The prospectus will include informationregarding investment risk and investors should have the financial ability and willingness to accept these risks. All information obtainedfrom third party sources is believed to be reliable and current, but accuracy cannot be guaranteed and we do not undertake to update anyinformation contained in this document. All assumptions, figures and calculations contained in the information must be independentlyverified by the professional investor. This publication has been prepared without regard to the specific investment objectives, financialsituation or particular needs of recipients. No legal or tax advice is provided. Recipients should independently evaluate specificinvestments and trading strategies. By accepting receipt of this publication, the recipient acknowledges that this publication is confidentialand agrees not to distribute, offer or sell this publication or copies of it and agrees not to make use of the publication other than for itsown general information purposes.

Copyright © 2015 LaSalle Investment Management. All rights reserved. No part of this publication may be reproduced byany means, whether graphically, electronically, mechanically or otherwise howsoever, including without limitation photocopyingand recording on magnetic tape, or included in any information store and/or retrieval system without prior permission ofLaSalle Investment Management.

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Anticipating Real Estate Capital Markets Downturns€¦ · to the economy, real estate markets, and capital markets. This paper expands the note on tracking and more importantly anticipating