A surge in activity on the global property market has triggered growth in the globalisation of property finance and the property securities markets. Neil Tyler reports.

In the past 10 years, the global property market has been utterly transformed. The diversification of funding sources, growth in market demand, a new and larger investor base and the proliferation of sophisticated financial and investment products have all contributed towards property financing becoming a key driver of capital and financial market activity.

Property finance and the property securities markets are globalising, allowing investors to gain access to a range of property investment activities around the world. In 2006, cross-border investment accounted for 29% of the total investment market, according to real estate consultants Cushman & Wakefield, up from 25% in 2005.

The international property market is continuing to boom despite fears about its sustainability. Last year, there were record levels of investment with more than E500bn of stock being traded, up 33% on 2005. Investors have continued to pour funds into a host of projects, ranging from the traditional (industrial parks, retail outlets, hotels and office developments) to the less common (nursing homes, car parking facilities, schools, airports and other infrastructure assets).

Property becomes attractive

As investors have re-appraised their investment portfolios, property has become more attractive. In the past five years, billions of euros have poured into the sector and speculative investment is on the increase. Concerns are mounting that the market is moving towards becoming unsustainable.

Deal volumes are surging ahead, driven by increased interest in real estate as an asset class. Strong returns are attracting even more buyers as a result. As more buyers enter the market, so more money enters the global property market and so prices continue to rise. Commentators are divided. Some talk of “irrational exuberance”; others that this is a period of structural change in the equilibrium value of global real estate.

Recent increases in interest rates in the UK may be having an impact on the domestic market. Figures at the end of 2006 suggest that the UK commercial property boom could be coming to an end. Prices began to fall at the end of last year and average net initial yields began to recover, rising to 5%, according to agents Lambert Smith Hampton.

While the commercial property boom may be easing in the UK, on the global market institutional investors are continuing to pour money into private equity, venture capital, and hedge funds that invest in real estate-related assets. A surprisingly diverse range of investors are looking at a number of markets across Europe, including Germany and the countries of central and eastern Europe. Other big movers are heading to the Middle East, Far East and India.

According to new research from the US, the commercial property market there could be poised to follow the residential market into a trough. The Urban Land Institute’s 2006 survey suggests that prices for all but the best offices and shops are set to fall unless rents rise substantially in the next two years. The biggest question for investors in the coming year will be: when will yields increase?

Debt finance

This surge in activity in the global property market has triggered dramatic growth in the availability of debt finance from all sources. Securitisation continues to boom as banks convert residential and commercial mortgages, corporate loans and other debts into saleable securities.

Real estate investment trusts (REITS) were launched in the UK in January this year. The move has been heralded as a significant positive development for the commercial property market in the UK because it will increase the options available to investors both in the UK and overseas.

Institutional investors have enormous sums to invest into the listed real estate sector. Issuance in the European market for bonds backed by assets is expected to grow significantly in the next 12 months. New issuance growth of 30% is forecast. If that proves correct, volumes could go beyond €500bn this year.

Areas that are performing well include commercial mortgage-backed securities (CMBS), where there has been continued growth in the size and number of deals. Investment banks have also been moving aggressively into CMBS by setting up specialist lending vehicles, known as conduits. Barclays expects CMBS issuance to grow by about 45% this year compared with 60% last year.

By far the largest section of the European asset-backed market is residential mortgage-backed securities (RMBS). Strong growth was reported in 2006, with UK banks responsible for nearly 70% of the growth in the market.

Bonds, backed by commercial property loans, are expected to remain one of the hottest areas of the European asset-backed securities market this year.

The strength of the market is helping to drive the disintermediation of banks as the main providers of capital. Growth in non-bank lenders, such as commercial mortgage conduits and specialist asset managers for the leveraged loans that finance buy-outs, are playing a significant part in the market’s continuing strong performance.

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