Commercial property is too cheap says the professor
By Robert Harley (afr.com – 23 August, 2016)
Commercial real estate is too cheap, at least according to one of the world’s leading real estate academics, Professor Andrew Baum.
Professor Baum, the Visiting Professor of Management Practice at the Saïd Business School at the University of Oxford, is in Sydney, as the first Powell Family Foundation Visiting Scholar in Real Estate Finance to support the University of Sydney Business School Real Estate Finance program.
On Thursday evening he will speak at the University of Sydney Business School CBD campus on the lessons from the European experience of real estate in a low interest rate environment.
Professor Baum acknowledged the stand-off in transactions as yields drop to record lows.
“But you have an extremely attractive risk premium over bond,” he said.
“If you get 1.8 per cent on a bond, why is real estate trading at 5 per cent? It would not surprise if the yields went down to 3.5 per cent.”
In Australia, the yield gap between property and treasury indexed bond yields is around 4.9 per cent, not as high as the record 5.7 per cent but well above the average 3.4 per cent.
Professor Baum said most people assumed bond yields would rise but with a glut of savings around the world it could be some time till they turn.
“It is possible that yields will stay low for a long time, in which case property yields could go lower.”
Professor Baum has three possible scenarios.
The first is that bond yields stay low, in which case, “property is a screaming buy”.
Bit of a cushion
The second is that real bond yields rise. Professor Baum estimates that the current yield gap could absorb a rise of 1 per cent rise in bond yield without any more in real estate yields.
“Real bond yields you have to rise 2 per cent before it affects real estate pricing,” he said.
“Markets know that and they have a bit of a cushion.”
The third scenario is that inflation expectations and real bond yields surge beyond the 2 per cent cushion.
“The question then is whether property is an inflation hedge,” he said, pointing out that over 35 years in the UK, inflation had averaged 3.2 per cent a year – and so had commercial rents.
Professor Baum says the second scenario is the most likely.
In the lower for longer world, “Australia looks good with a relatively high property yield relative to local bonds.”
And the UK after Brexit? “We will see prices fall a bit, yields will go up from 4 per cent to 4.5 per cent,” he said.
Professor Baum is a chartered surveyor and a Fellow of the Urban Land Institute. He has held a range of academic posts as Professor of Land Management at the University of Reading and Honorary Professor of Real Estate Investment at the University of Cambridge.
But he also has his hand in the real world, as chairman of Newcore Capital Management and Property Funds Research and chairman of the investment committee for CBRE Global Investment Partners.