Property/ Developer/ Industry Dynamics 4 comments
(P.S: The following were extracted from another source and is not my original work.)
Property prices typically follow a cyclical pattern, lagging the economic cycle compared with stock markets. In periods of high inflation this means that price inflation varies between slow and fast. However, since 1990, with the major economies experiencing very low inflation or even deflation, property prices in many countries have shown periods of outright decline. The property cycle is driven by the interaction of changes in rents, changes in expectations of price increases and interest rates.
Residential demand is driven by confidence about employment and growing incomes, which reaches a high during the late upswing phase of the economic cycle. Also people are frequently seduced by rising house prices and want to participate in the apparently easy gains. They therefore buy houses larger than they really need, thinking of it partly as an investment. Expectations of future price gains are high and the risk premium is low. Rental yields decline despite rising rents.
When the recession bites, demand falls sharply and house prices start to slide. In most markets house prices adjust relatively slowly and this slide often continues through the recovery phase of the cycle as well. After a severe recession consumers will still find jobs hard to find right through the early upswing phase. Moreover, they no longer believe housing is such a good investment and therefore are interested in buying only if they need the space. But many people already have enough space because they overbought during the previous upswing. Also, the risk premium is high at this point, particularly if house prices are still substantially below their peak and some owners face "negative equity". Only when the economy moves into the late upswing phase of the cycle, and unemployment is low, do prices start to rise again significantly.
Commercial property follows a similar pattern. During the late upswing phase demand for property is particularly strong and rents rise. Demand is strong both because of the buoyant economy and also because companies are doing well and frequently seek new, more prestigious offices. They also look to grow so look for offices and factories with room to expand. Demand for retailing space is strong too because consumers are spending heavily and new stores are starting up in large numbers. At this point developers start to build new property at a relatively rapid rate. Land prices rise as the supply of new land with permissions to build declines.
When the recession comes, all this goes into reverse. Companies retrench staff and are content with smaller, less impressive space. New start-ups are less common. Consumer spending growth slows and there are fewer new retail stores while some of the old ones fail. Often demand falls just as new property planned during the upswing phase comes on stream, driving rents sharply lower. Property prices inevitably follow, but fall even faster so yields are driven up.
(The above was extracted from a chapter on property in The Investor's Guide To Economic Fundamentals)
References:
(1) The Investor's Guide To Economic Fundamentals
posted by DanielXX at 2/20/2006 11:34:00 PM
4 Comments:
An alternative approach is to look at the nature of cashflows.
where the cashflows are short term, the cycles move closely with the economy. e.g. contract manufacturing, paid by the contract which is completed within the year.
For cashflows that are locked-in, e.g. lease-type cashflows, which are fixed for say 2-3 years regardless of the economy (short of default), the correction to match the economy will be delayed.
Once this is understood, its clear that one way of predicting future performance of a ppty company is to look at the structure of its leases, if such data is available.
Thanks, that is a new and very useful insight. Two points: (1) I would assume most commercial, retail and industrial property work on such medium-term locked-in leases? (2) perhaps detailed information on the various lease agreements on a property company's different properties might be hard to dig out?
generally anchor tenants wld have longer leases.
otherwise, for retail, the leases are generally short. (less than 3 yrs to 1-yr leases per term.) renewals depends on the contract. usually option to renew is on the lessee (since they spent so much money on renovations, don't make sense if you kick them out after 3yrs.), but at preagreed rates. (see who has greater bargaining power)
Industrial leases are usually long, especially for sale-leaseback type transactions. (industrial properties are more specialised)
Agree that such info is hard to come by, hence more applicable for internal analysis, and analysts seldom do this (too much work. but that's also becoz they don't have to be that accurate in their estimates) But, it is possible to deduce general profile on a case by case basis (no hard and fast rule). For example,it is known in the property mkts that Suntec is going to have an exodus of existing tenants, since it will jack up its rates to improve yield. It will have a high proportion of new leases, and from there, generally longer maturities.
For mature properties, unless there are anchors that has been there for many years and takes up several floors, the tenant turnover generally averages out. (i.e. 30% of the floor space will be affected by changes in rental rates annually, if average lease life is 3 yrs)
etc
Hence, detailed info not available, but general nature/profile can be deduced, and from there, how much the property is benefiting from rising rental rates arrived at.
Thanks for your expert views, it appears that different buildings might have to be evaluated individually based on their lease structures. I generally use historical trends and yields as a guide and might miss out turning points as a result.
Cheers.
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