Benchmark for Liquidity

Market liquidity has previously been difficult to define and measure in real estate investments, but that has changed. Investors are benefiting from a new benchmark metric for risk management which captures liquidity risk.

Institutional investors are flocking to European real estate investments to pick-up additional yield, as years of record low interest rates in the decade since the Global Financial Crisis have eroded returns in their core fixed-income portfolios, reducing the coverage of their long-term liabilities in pension schemes and insurance policies.

The wave of capital seeking returns from rental income has not only increasingly flowed in alternative property sectors, such as the logistics industry, residential living, healthcare industry and hotels, it has also spilled over into cities that were not previously the prime destinations for institutional investors. As a result, the overall structure of these markets is changing towards more ‘core-like’ investment locations, and they are becoming deeper and more liquid, anchored by the intrinsically more ‘long-term hold’ nature of institutional capital, which tends to reduce price volatility and therefore also risk.

A matter of definition

Real estate market liquidity is the traditional ‘Achilles Heel’ of an asset class where it can take months to sell a building at the best of times and it may be almost impossible during crashes where deal flow dries up. It is well known, that there are few, if any, references for gauging falling values. But perhaps surprisingly, given its huge importance as an indicator of the health of a market, liquidity has previously been difficult to define and measure in direct property investments.

Therein lies the challenge: if you cannot measure it, you can't manage it.
Tom Leahy, Senior Director of EMEA Analytics at Real Capital Analytics

“Therein lies the challenge: if you cannot measure it, you can’t manage it,” says Tom Leahy, Senior Director of EMEA Analytics at global property data company Real Capital Analytics (RCA). In liquid real estate stocks, share price volatility is used as a key measure of risk like other equity sectors, but in non-listed real estate funds the movements in the underlying asset values may not be registered until six months down the road, at the next valuation of the portfolio. The trough in most markets in Europe occurred ten years ago and even though ultra-low interest rates appear to be sustaining investor interest in real estate for the time being, a correction at some point is inevitable.

Key issue for investors

The ability to assess market liquidity and how markets have reacted during corrections in the past is therefore a key issue for investors. The need for a benchmark metric that captures liquidity risk has been given increased importance by the Europea Union’s Alternative Investment Fund Management Directive (AIFMD), which stipulates that alternative investment funds, such as real estate, must provide a description of a fund’s liquidity. Real Capital Analytics has developed Capital Liquidity Scores™ that are calculated based on factors such as the overall volume and number of unique buyers in a market, as well as the percentage of capital that is institutional, how much of the global pool of cross-border capital the market accounts for and how much is derived from the world’s largest property investors.

Relationship between metrics

RCA’s research shows that most European markets are well above their long-term averages in capital liquidity scores, indicating the maturity of the current cycle. Six markets were at new liquidity records at the end of 2018: Central Paris, Lyon, Madrid, Lisbon, Hamburg and Dublin. Analysis of the RCA Capital Liquidity Scores and average transaction yield shows a clear relationship between the two metrics. To access stock in Europe’s most liquid markets – London, Paris, German A cities and Tier 1 cities such as Madrid, Amsterdam and Stockholm – investors must pay a premium.

RCA research shows that for every point of liquidity, investors can, on average, expect to take off five basis points from their initial yield. Conversely investors are rewarded with higher yields for taking on the risk of investing in less liquid markets. 

Some markets are also more intrinsically liquid than others and even in the depths of the financial crisis, in the first quarter of 2009, over one hundred Central London office properties were traded. That represents a third of the number that were transacted during the second quarter of 2007, but the market did not grind to a complete halt. Markets that offer greater levels of liquidity during a downturn, therefore, also provide a relatively safer haven than those that do not. The way in which a market’s liquidity can dramatically change is shown by the contrasting experiences of London and Dublin in recent years.

Dublins real estate resurgence

The transformation in the fortunes of Ireland’s economy and turnaround in Dublin’s real estate investment sector since the crash in the financial crisis ten years ago has propelled the Irish capital up the rankings of the world’s most liquid property markets.

Central London, in contrast, was ranked as the most liquid real estate market globally on the eve of the Brexit referendum vote in June 2016, but had slipped to 10th place at the end of last year among 155 international markets covered by RCA’s Capital Liquidity Scores. New York’s Manhattan commercial real estate market, the other truly global property investment destination, has maintained its post-crisis level of liquidity and remains the most liquid market in the world.

Dublin’s resurgence and London’s fall from grace

“Dublin’s real estate investment market is one of the great recovery success stories of the post-crisis European property market cycle. The market has moved from being debt-driven and dominated by local players before 2008, to a recognised international institutional investment destination where pension funds and other investors are comfortable in placing their equity in offices, private residential and other property sectors,” says RCA’s Tom Leahy.

Many of the largest tech companies have set up operations in Dublin, including Facebook, whose European headquarters are located there.

As prices have risen and yields compressed, RCA’s liquidity benchmark showed Dublin’s score climbed to a record high at the end of 2018. Dublin has greatly benefitted from the growth of the global technology, media and telecoms sector and is home to many of the world’s most recognisable tech companies: Facebook pre-leased over 800,000 square feet of space in the Ballsbridge district of the city in 2018 in one of the market’s largest-ever deals and Alphabet (Google) also forward-funded the development of the Bolands Quay site in Dublin’s docklands for its new office campus.

Rapid growth

Demand from these occupiers has driven take-up of office space and the subsequent employment boom has also boosted the Dublin residential market, where prices are up 55 percent in the last five years. Both trends are visible in the property investment figures (particularly for private sector residential properties, where investment more than doubled to €970 million in 2018, in comparison with €400 million in 2017) and the record-high RCA liquidity score. Dublin is now ranked in the Top 25 of the world’s most liquid real estate markets. That compares with the city’s ranking at 151st out of 155 global markets, just ahead of Cape Town, Guangzhou, Australia’s Gold Coast and Milwaukee, during the financial crisis. 

Following its purchase of the new office building Five Hanover Quay (right), Union Investment manages five commercial properties in Dublin with a total value of over €620 million. The vision behind Dublin’s Bolands Quay development (below) is about creating a campus in the heart of the city. A lively new outdoor area for both working and living in the city.

By Steve Hays

Title image: SAKhan Photography/shutterstock

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