With a background of urban planning, Prof Key, started as a consultant and forecaster at Property Market Analysis also worked as a Research Director for Investment Property Databank  (IPD) the global leader in property indices and benchmarking. Here he gives his views on the real estate market.

Can you comment on the ‘real estate hyper-cycle’ that occurred in Dubai?

From the viewpoint of a global market analyst, the first point to note is of course that Dubai was part of a bout of global property exuberance with common features – a ramping up of values, huge rise in leverage, poor loan underwriting by the banks – in many countries.

The second point is that this should not, perhaps, have been that much of a surprise.

The last ‘global’ crisis, triggered by the financing of US housing and exacerbated by huge losses in commercial property, can be seen as the culmination of a series of property-linked financial crises running back 40 years.

In that period we have seen the UK Secondary Banking Crisis (1970s), the US Savings and Loans Crisis (1990s) followed in the early 1990s by banking crises in Scandinavia and Japan, and in the later 1990s by the combined property, banking and currency disruption of the Asian Crisis.

The details of these events differ; the basics – real estate price inflation driven by rising leverage which later turns out to have been ill-conceived – are the same.

The crises, in my view, form a series of ascending severity and scope – from problems confined to one country and part of the banking systems all the way out to the Global Financial Crisis.

We should, therefore, regard real estate financing as the signature crisis of the last fifty years, with a strong possibility of a recurrence in the not too distant future.

China is even now trying to choke off a property boom triggered by high growth and loose credit control.

So what happens in counties like Dubai, aiming to sustain extremely high growth rates led by property development?

They are expanding their property stock at a high rate.

New development has a ‘fatal attraction’ for the property and banking industries: it has drama, delivers a fairly quick and highly visible sense of achievement, soaks up vast amounts of capital and – when it comes off – high levels of profit.

Success sucks in more capital, more capital drives up asset values and we have a bubble. 
In a developed economy, which is growing its property stock at perhaps 2% to 3% per year, a collapsing commercial real estate bubble may be unpleasant but not desperate.

In counties which, to sustain high economic growth, are trying to expand property stock by 10% or more per year, the shock of a year or so of falling property demand will obviously be much deeper and last longer.

There has been what we might call hyper-cycles – massive expansions of development, huge rises in values followed by collapse in a growing list of high growth economies.

Dubai, given the kind of growth rates it was aiming for, and the leading role of property development in sustaining that growth, is just an extreme case of a general phenomenon.

More worryingly, perhaps we should consider the possibility that history suggests that periodic crises are close to an inevitable part of that growth process, that the common notion that we have “learned from the last crisis” turns out to be wrong.

Looking elsewhere, which global property investment markets have seen the best performance over the last few years?

I have to give a partial answer, because there are many markets – including Dubai – where I have no reliable measure of the returns investors have actually received.

The newer, often the most more interesting, property markets like China and India still lack the base of institutional investors and regular valuation which, in the absence of “stock markets” for property, are needed to measure returns.

For the markets we can track fairly well, recent performance of course depends on the severity of their market crashes, and how far they have managed to bounce back.

On IPD’s figures (which cover 22 countries), the bigger mature markets already into recovery – UK, USA, France, Canada – all had returns of 10% to 15%, the top end of the range for 2010.

Over five years, the best markets have been the most distant from the disasters of the “North Atlantic” banking system: only South Africa and Korea have returns over 10% for that period.

Over ten years, all countries except Germany, Ireland and Japan have recorded total returns at or better than the 7%-8% per year we’d take as par for the course in property, but only three – Canada, Australia and South Africa have topped 10% a year.

Where are international investors choosing to invest? How has this changed over recent years?

In the first phase of the recovery, there was a flight to safety by mainstream institutions.

The best quality buildings in core markets like UK, France, Germany, USA.

Prices for that trophy stock have, in those markets, risen vary fast, helped along by a large flow of money from the sovereign wealth funds of oil-rich and Asian countries.

In 2010, the Norwegian State oil fund bought into London’s Regent Street in a joint venture with the Crown Estate – an extreme case, but typifying that stage in the market.

And of course large Western investors are very keen to buy into the growth story of Asian and Latin American markets, though they find it very hard to find the stock that would meet the investment criteria they like to set in mature markets.

What would you say are the main lessons that have been learnt over the past decade?

One positive lesson. It has proved possible to create a genuinely global market in property investment, which did not really exist a decade ago. We now have structures and skills which, for good or ill, can move investment capital across the globe in a variety of investment structures open to institutional and, increasingly, individual private investors.

The negative lesson. Property investment is, given its risk profile, an asset that we should expect to deliver moderate returns, somewhere between equities and bonds. Chasing much higher target returns from property through development, emerging markets and high levels of leverage will, ultimately, result in disappointment and loss.

What do you think investors will do differently now?

So the current mantra among investors is now that they will avoid high risk markets and aggressive financing: modest ‘core’ returns and low risks, mature markets like UK, France, Germany and the US are at the top of the target lists of mainstream investors.

Sadly, it may also be true that this ‘lesson’ will be forgotten, perhaps a lot sooner than anyone expects, and that real opportunities to earn high returns in deeply distressed markets like Southern Europe are being sidelined. 

Where are Middle Eastern investors currently putting their cash? What trends have you noticed?

Generally, to pay down the bloated debt built up in the boom needs a lot of equity finance.

That puts cash-rich investors in the driving seat for the financing of new development.

For that reason, we will see Middle Eastern investors as big players in large-scale developments in countries like the UK and US.

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