How $1 Trillion in Real Estate Bets Threaten a New Great Recession

via investopedia:

As stock prices climb to new record highs, an overlooked trend has been the large amounts of money being poured into real estate investments. Big U.S.-based institutional investors, notably pension funds, now have about $1 trillion in real estate, or roughly 10% of their portfolios, according to a report in Business Insider. Moreover, a record 22.5% of these real estate investments is in the riskiest and least liquid segment of the market, so-called value-added properties. Additionally, a record 9.5% is in foreign real estate, which can be just as risky.

“People did a lot of this in 2006 and 2007, and it didn’t end very well when you got to 2008 and 2009, because buildings that were half-built and buildings that were half-leased performed very poorly,” observed Joe Azelby, head of real estate and private markets at UBS Asset Management, during a recent UBS conference, as quoted by BI. “The thought is I’m going to move out the risk curve to either develop, redevelop or do higher-risk, higher-reward activities in order to get a higher return,” he added.

Significance for Investors

Value-added real estate typically is purchased with the intent of reselling it for a gain. However, increasing its value often requires significant additional investment in upgrading, rehabilitation, or redevelopment. The payoff on these additional investments is uncertain during economic expansions, and more so during economic downturns.

Institutional investors historically have preferred safer core real estate assets, as they are called. These properties typically offer reasonably secure streams of rental income. However, with interest rates at historic lows, and the yields on new investments in core properties having declined accordingly, many institutions are seeking higher returns with value-added investments.

Meanwhile, Oxford Economics sees a significant slowdown in the global housing market underway, and this has has negative implications for global GDP growth. Their proprietary gauge indicates that, on average worldwide, home prices are down by 10% and investments in housing are off by 8%, MarketWatch reports.

“Downturns in world housing markets have been important contributing factors to global recessions over the last thirty years, most dramatically in 2007-2009. As a result, the current slowdown in global housing is a cause for concern,” Oxford Economics says in a recent report, as quoted by MW. “A combined slump in house prices and housing investment in the major economies could cut world growth to a 10-year low of 2.2% by 2020–and to below 2% if it also triggered a tightening in global credit conditions.” they add.

Looking Ahead

Residential real estate in the U.S. already is in a slowdown. Spending on private residential construction is down by more than 11% since April 2018, Barron’sreports. Sales of new homes are at a five-month low, single-family home sales overall are down from a year ago, gains in home prices have been decelerating for 13 months, and the median price of a single-family home is down from a year ago, per various sources cited by Bloomberg.

Moreover, in June, the Consumer Confidence Index (CCI) fell to its the lowest level since September 2017, suggesting yet more trouble ahead for housing and the general economy. If so, risky bets on value-added real estate may begin to unravel.