Are there still opportunities in global property?

The worldwide housing bull market is on its last legs. But not all countries are equally vulnerable to a downturn. Sarah Moore surveys two that are still worth a look; elsewhere, Jonathan Compton highlights two in big trouble.

In February 2018 the Emperor Group in Hong Kong unveiled a rather clinically named property development. “The Unit” comprised a block of 68 serviced apartments. Sixty-four of these were “nano” flats with floor areas as small as 91 sq ft – about the size of two king-size beds. But despite the tiny floor plans and rents of £1,100 per month, nearly all of the flats were occupied within a few months.

It’s not just Hong Kong. Absurdly expensive housing markets have become a global phenomenon. A decade of record low interest rates has fuelled massive house-price growth from the UK to Australia. These days, “homes in the posher parts of global cities move in sync because they have become a distinct asset class”, as Buttonwood puts it in The Economist. A global market of buyers made up of rich individuals from both developing and emerging markets, investment trusts and private-equity firms have snapped them up, driving up the prices of smaller properties nearby. Chinese investors in particular have been a key driver behind booms in Sydney and Vancouver, for instance.

The global tide is going out

But the global property boom is now going into reverse. Global interest rates bottomed in 2016. Central banks are now either removing stimulus or actively tightening monetary policy (as in the US). This raises the cost of mortgages and crimps affordability, making overvalued markets more vulnerable to reversals. House prices relative to incomes are 73% and 48% above the long-term average in Auckland and Sydney respectively, for instance, says Buttonwood. As local residents have been priced out, governments have begun to tighten lending standards and to tax property more aggressively – witness Britain’s 12% top rate of stamp duty. They are also increasingly asking awkward questions about where people’s money comes from, and with good reason. According to Canada’s Global News, more than 10% of 2016 property sales in one area of Vancouver were “tied to buyers with criminal records”.

“House prices in Hong Kong have gained 10% a year since 2012; apartment prices have tripled in a decade”

Hong Kong, which took the top spot in investment bank UBS’s latest Global Real Estate Bubble Index, now appears to be heading for a bear market. House prices in Hong Kong have gone up by 10% a year on average since 2012, according to UBS. Apartment prices have tripled in a decade. But now one house price index is down by 5% from its August peak, says Jacky Wong in The Wall Street Journal. Buyers from the mainland are cutting back as Chinese growth decelerates; sales at luxury watchmaker Richemont have slowed. Banks in Hong Kong are “aggressively cutting property valuations as the city’s housing market weakens, threatening to fuel a downward spiral in prices”, according to brokerage CLSA, quoted on Bloomberg – the risk is that lower valuations mean less lending, which in turn will hit prices. All of this describes a classic housing-market slump. But not all foreign markets look poised to follow the world’s most overheated into a downturn. Here are two that still offer opportunity.

America: a slowdown, not a slump

America looks set for a slowdown rather than a slump. The latest Case-Shiller national home price index shows prices are rising at an annual pace of 5.5%, the slowest pace in two years. “Buyers are getting squeezed by rising mortgage rates and by prices climbing about twice as fast as incomes,” say Prashant Gopal and Sho Chandra on Bloomberg. Capital Economics notes that over the four months to the end of September, house-purchase mortgage applications fell by a cumulative 12%. Mortgage interest rates also rose above 5% in October for the first time since 2011, while interest payments for a median-income household buying a median-priced house have climbed to 17%, a ten-year high. That said, the affordability of a median-priced property is still more favourable than at any time from 1973 to 2008, says Capital Economics. “But that is not much help for househunters when there are no median-priced homes for sale.” Lower-cost houses are especially scarce, reports the Joint Centre for Housing Studies at Harvard University.

Still, inventory levels (the active supply of properties on the market) are close to record lows, which will help to prevent a sharp drop in prices. “Coupled with the fact that homes are not obviously overvalued when compared with incomes or rents, without a major economic or financial market shock, all that suggests that another house-price crash is certainly not inevitable,” says Capital Economics. Furthermore, the housing sector in the US is helped along by a healthy labour market and steady economic growth, say Gopal and Chandra on Bloomberg. This points towards a stabilising trend for house prices, rather than a sharp decline.

Invest in renters, not buyers

Given the shortage of affordable houses to buy, it’s no wonder that an emerging sub-sector of the US housing market is “build-to-rent”: the development of houses specifically to be rented out rather than sold, with properties, or shares in the properties, generally owned by institutions such as pension funds that are looking for the reliable income provided by rental payments. Unfortunately, at present it’s not very easy for individuals to invest in the sector. Two of the largest build-to-rent operators in America – Greystar and Cortland – are private firms, while other listed funds are only available to institutional investors.

However, it is possible to invest in smaller residential funds, usually in the form of a real-estate investment trust (Reit). The AvalonBay Communities (NYSE: AVB) Reit develops and operates “multi-family communities” across the US, mostly on the east and west coasts. As of 30 September, AvalonBay owned or had an interest in 290 apartment communities, totalling 84,490 apartments. Although the growth of AVB’s “funds from operations” (a gauge of a Reit’s cash flow) figure is expected to slow to 4% (down from 5.3% in 2017), there is scope for faster earnings and dividend growth next year, reckons Bloomberg. The stock currently yields just over 3%.

“A healthy labour market and steady economic growth are bolstering the US housing market”

Equity Residential (NYSE: EQR) is another Reit. It owns and manages flats in “urban and high-density suburban coastal gateway markets”. It owns or has a share in 306 properties, making up 79,412 units. EQR’s portfolio is “high-quality and geographically attractive”, says JPMorgan. Although it thinks growth (of net operating income) may be “muted” in the short term, over the long term it should be “above average”. It yields 3%. Finally, Apartment Investment & Management Company (Aimco) (NYSE: AIV), owns properties in “second-tier” markets such as Denver, Philadelphia and Miami. Aimco has shrunk its portfolio by around 75% since 2006 in an attempt to boost asset quality, says Bloomberg. “A”-quality apartments now make up 51% of its portfolio, and the higher quality has “lifted margins and net operating income growth”. The average rent in its portfolio is up 6% in 2018. The yield is 3.3%.

Germany’s property upturn

After decades in the doldrums, the German property market has suddenly come alive in the past few years. German property prices in 2017 had their strongest period of growth in at least three decades, according to figures from Fitch Ratings. House prices in large metropolitan areas went up by 80% between 2009 and 2017, says Deutsche Bank. Low interest rates, strong economic growth and low unemployment have underpinned growth. Berlin has seen the fastest house-price growth. In March, the capital city came out on top of a global ranking of 150 residential property markets put together by estate agent Knight Frank, “sealing its transformation from a grungy backwater to one of Europe’s most sought-after locations”, says Andrew Blackman in Bloomberg. Asking prices in Berlin were up by more than 20% year-on-year. Three other cities – Hamburg, Munich and Frankfurt – also made it into the top ten, with increases of over 13%.

While property in major German cities looks overvalued by past standards, the uptrend is likely to continue for several more years, reckons Deutsche Bank. German house prices started from a very low base. Several factors could change the outlook: a huge rise in the number of new houses built; an abrupt drop in demand due to less immigration; a switch towards renting because purchase prices have got too high; and a sharp increase in interest rates. But at present there is no sign that the first three factors are imminent in any major cities, says Deutsche Bank. And while interest rates are likely to go up in the years ahead, the European Central Bank is unlikely to be in a hurry. Given the broadly auspicious backdrop, one investment option may be Vonovia (Frankfurt: VNA), the largest residential landlord in Germany.

It looks after a €38.5bn portfolio of more than 394,000 units, and also manages roughly 58,000 units for third parties. For the half-year to July 2018, it received rental income of €838.8m, and made €354.2m from selling properties. Its earnings before interest, tax, depreciation and amortisation (Ebitda) were €680.9m. Deutsche Wohnen (Frankfurt: DWNI) is the next-largest residential landlord, with a €20.8bn portfolio of more than 160,000 units across Germany (although around 70% are in Berlin). The smaller Grand City Properties (Frankfurt: GYC) specialises in buying “turnaround” properties in densely populated areas across Germany. Its rental and operating income for the six months to July was €268m, up 12% year-on-year, and its Ebitda was €137m. Interestingly, it owns 400 units in London, comprising about 5% of the portfolio’s value. As of June 2018, the portfolio was valued at €6.86bn. London-listed Phoenix Spree Deutschland (LSE: PSDL) is also worthy of further research. It is a smaller operation focused on Berlin, with a portfolio valued at €609.3m.