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Who doesn’t have a shame-list of investments they have declined? Apple shares when Steve Jobs rejoined in 1997. Bitcoin a decade ago at 10 bucks. An ex-colleague told me his Hungarian mother refused Ernő Rubik some money for a toy he’d invented.
Lost opportunities? I’ve had so many it’s embarrassing. The worst was Miami. Long before I made a joke about the city being underwater and lost my job, I spurned a fortune by not buying property there. Man, does that place owe me.
It was when I was living in New York during the darkest hours of the financial crisis. Markets in freefall. Banks imploding. “For rent” signs everywhere. The collapse of the subprime market in Florida was rattling the world.
As they do, investors lost their grip on reality. Miami was over. No one would ever live in the Sunshine State again. Just look at the valuations of rental car firms, cruise ships and airlines — travel was a thing of the past.
Clearly this was nonsense and the smart money swooped. A friend bought an apartment overlooking the water with the biggest terrace I’ve ever seen — for five figures. Everyone said he’d overpaid.
But Miami was going nowhere. Its beaches were still white, its weather amazing. Latin America remained just over the horizon. The city recovered and house prices clocked up 130 months of consecutive annual gains to September last year.
I didn’t buy — but promised to heed my lesson. Hence my ears have pricked up since everyone is predicting the end of commercial real estate. I’m reminded of the universal defeatism and illogical extrapolations. I smell a familiar bargain.
The fear is that Covid-19 has landed commercial property a mortal blow — particularly for offices, which account for almost half the sector by value. Just as American snowbirds were never migrating to Miami again, so workers are done with working in buildings.
Office vacancy rates in the US, for example, rose back above their pandemic highs in the fourth quarter of last year. In the UK, only about 30 per cent of offices are occupied — half pre-Covid levels.
It’s less bad for newer buildings with gyms and wellness rooms. But for so-called “secondary” offices in crap neighbourhoods, it’s over. Or so the bears argue. Industrial, logistics and retail properties are also suffering.
That’s only half of it, claim the naysayers. Commercial real estate sales are reliant on debt funding. Higher interest rates and nervous lenders post-Silicon Valley Bank are choking finance. Bank loan books are under stress.
Which is why commercial mortgage-backed bonds are also being pummelled. US investors are worried that a fifth of outstanding mortgages are maturing this year, according to Moody’s data, with a quarter of those backed by offices.
If owners have to refinance at higher rates, they will need to raise rents considerably to maintain debt service coverage ratios. Good luck with that, we’re told, especially as capital values are falling, too. The term “credit crunch” is back on tongues.
So OK, sure — there are risks out there. What matters for investors, however, is whether they are in the price or not. The big US real estate trusts have already lost anywhere between a quarter and half of their value. The average initial yield for commercial property in the UK is above 5 per cent.
A quick explanation is needed here. The industry most commonly uses two definitions of yield. Initial yield is rental income after costs divided by what was paid for a property. So-called “cap rates” use a current valuation for the denominator instead.
Anyway, both are not only more attractive than they used to be, but also compared with other income generating assets, such as government bonds. A premium over 10-year gilts of 1.5 to 2 percentage points for UK commercial property, for example, is just shy of its average over the past three decades.
Meanwhile, the spread between high-grade corporate credit and commercial mortgage bonds is the widest it has been for more than a dozen years. Of course, this could mean the former are overvalued. But it also suggests an excess of pessimism in and around commercial property — at least versus history.
While the spreads are not screamingly cheap, don’t forget they are aggregate indicators, which include bits of commercial real estate that are holding up — such as warehousing. I’m more intrigued by secondary offices. These are either found in old buildings or Hicksville.
According to the latest CBRE survey, cap rates for such offices are pushing double digits in America. That’s well worth a look in my opinion. Especially as I do not buy the ubiquitous argument that old buildings are obsolete — stranded assets, in the trendy parlance.
This matters because offices built before 1980 make up almost a third of the stock in the US, for example. And 80 per cent of those are what property investors label as B or C (A is best). It’s about the same globally, too. Are these tired buildings — as Miami was told — really done for, though?
Surely not. I’ve seen derelict warehouses on the Thames morph into super pads. Wall Street is residential now. And do employees care how old their building is? Start-ups work out of garages or industrial spaces with pipes everywhere. Just pay a good wage and be nice, boss — we will come!
No, I won’t make the Miami mistake again. Offices aren’t joining the dinosaurs just yet. But do any readers know of any property funds that focus exclusively on the supposedly doomed end of the global office market? I cannot find any.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
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