By Miguel HernÃ¡ndez, Director of the Advanced Programme in Real Estate Business Management at IE Business School. Member of the Royal Institution of Chartered Surveyors
At times of uncertainty, such as the present, it is of fundamental importance to consider the basic principles and concepts on which real estate is based. We have had such frenetic years that daily routine has taken away our mid-term vision and perspective. I also remember where we have come from. Accordingly, I consider five questions and offer one thought on the current situation.
What is understood by the â??real estate sectorâ??
In recent years, the sector has become so sophisticated that the activity related to real estate has very different focuses when seen from the viewpoints of product, location, operators, capitals and demand.
What may be a crisis for developers is an opportunity for demand and, what is seen as the contraction of finance opens up the door to higher profitability for own resources. There are areas in the world where cycles come to an end and there are others where they begin. There are product segments that run out and others that offer better investment possibilities.
In short, we can speak of a residential crisis in Spain for developers and banks, but there are also high levels of profitability to be gained from investments in Russia or Turkey in the development of low-geared shopping centres.
Can we speak of only one â??real estate sectorâ??
Does an apartment developer, a REIT (Real Estate Investment Trust) trader or a listed company analyst speak about real estate? Of course they do, but the part of the sector in which each one is interested is completely different. Everything is related, but there is a â??level of technologyâ? that is so specific for all the operators in the sector that it is almost impossible for the information on each area to be consistent. Indeed, work is carried out independently.
This graph shows investment outlooks by asset type and reveals the numerous alternatives by product, geographical location and investment format.What is the relation between financial markets-fiscality and real estate product by location?
The local component, which is characteristic of the sector, has two sides: on one hand, the properties are located in a certain country and subject to the corresponding legislation; on the other, the investment vehicles have their own regulations and fiscalities. The possibilities are almost endless and competition is global but subject to local peculiarities (e.g. funds in one country with reduced fiscalities purchasing assets in other locations under the principle of legal certainty).
Furthermore, as shown in the diagrams (see next page), the different investment styles adapt to the markets according to the moment of the cycle in which they are immersed.
Are there any artificial parameters that distort the different real estate markets?
One of the great problems facing the opaqueness of the sector is information. For some years now, institutions such as the IPD (Investment Property Databank) and the ULI (Urban Land Institute) have been making commendable efforts to provide consistent data that make statistics for the different countries more transparent.
Despite this progress, there are still two voids in data consistency that distort market perception: the valuation of assets and accounting. Legislation differs in each country and the criteria are too open to interpretation. Many of the excesses in the sector are the result of aggressive valuations or creative accounting. The new accounting standards and the criteria of the Royal Institution of Chartered Surveyors (RICS) are applied in more and more countries, and reveal improvements in the mid-term.
Are innovation and the creation of value in the sector still possible?
Undoubtedly so. We have witnessed years of sophistication in the organization of transactions where the legal-fiscal, financial and product management points of view are of importance. Today, not working with teams of lawyers, tax experts, financial experts and market experts on each project is unconceivable.
Whatever the case, the overall view has been lost. At the present time, new, more flexible business models that are open to change are appearing with a higher level of adaptation to circumstance â?? instead of traditional funds (with military-model organisation), innovative vehicles (with warfare philosophy) are appearing to attack specific objectives with reduced resources but with a great deal of â??real estate technologyâ?
And in view of this situation and at this moment of uncertainty, what can we expect?
The real estate sector is a real alternative for capital investment. This process is irreversible. Money needs new â??securitiesâ? that do away with the effect of the psychological fear generated by the subprime mortgages. The â??real estate product generatorsâ? must assume this challenge and, accordingly, there is only one alternative: â??back to basicsâ?.
Real estate is based on two pillars: location and demand. These are the first things that have to be managed. In Spain in recent years we have forgotten these principles and developed in unwonted places with no demand to back up the developments. For the Spanish market to become competitive again in comparison with other places, there is only one solution: price adjustments adapted to the location. As Professor CÃ©sar Barrasa says: â??The idea of a square metre of new housing in Villaverde (Madrid) being more expensive than in the best quarter of Berlin is unthinkable.