In spite of a slowdown over the third and fourth quarters, transaction activity in Manhattan nearly doubled the prior year’s tally during 2011. Surpassing $20 billion in new equity and debt, investment in support of property trades was still only a fraction of the market’s pre-recession peak. But recast in terms of sustainable activity, volume is quickly approaching the nominal level of sales from the prior decade. With a finite set of assets available to esurient investors, prices have necessarily recovered the lion’s share of their losses. As confidence in the underlying economic recovery firms, should well-heeled investors make more concerted efforts to invest beyond the core properties that have dominated activity thus far?
What’s Kept Us in Core So Long?
Listed REITs, pension funds and cross-border investors dominate the investment inflows that have fueled the recovery. Sharply higher prices in the handful of cardinal markets that monopolize their attention have motivated a new construction pipeline and an uptick in development site trades. Where fundamentals cannot fully explain rising valuation trends, liquidity has been a factor in concentrating capital and reflating prices. The tradability of assets—including ex-ante expectations of exit strategies—figures prominently in decision making when the broader context of investment is unusually uncertain.
Investors who might have avoided risky assets altogether have been pushed into risk-taking sooner than if incentives were not being distorted. The nudge comes from monetary policy that has ensured negative real returns on the risk-free investments. Historically low yields on Treasuries and the near-certainty of falling Treasury prices as the economy improves preclude investors meeting targets through this channel. The result has not been an abandonment of caution. Rather, institutional investors have balanced these competing pressures and found centers of gravity in markets with well-diversified and self-reinforcing clusters of buyers and capital.
Time to Think Outside the Box?
For investors dependent on secured financing, there is a growing risk of overly accommodative lending in support of the most coveted assets. All things being equal, spillovers into secondary opportunities are a predictable means of rebalancing when risk-adjusted yields diverge in an otherwise efficient market. The assumption of market efficiency is contestable, however, at least in our present circumstances. Just as some markets might be suffering from an excess of liquidity, some markets where fundamentals are more stable may be starving for capital. Spillovers have been far more limited than Manhattan’s current cap rates would suggest, more so than can be explained purely in terms of cash-flow uncertainties.
As the underpinnings of exaggerated risk aversion abate, the move into higher yielding assets can accelerate. For many investors, the crucial determination revolves around the durability of the economic recovery. There are observable reasons for optimism. The job market—the major missing link in the recovery—has shown clear signs of firming. Initial claims for unemployment insurance are at their lowest levels since early 2008, which may presage an improvement in the abysmal pace of hiring. Stock markets have rebounded, which has buoyed consumers’ confidence.
When venturing forward, investors must still strike a balance that will favor the best-positioned assets within any class of metropolitan area or development landscape. While domestic markets have brushed off the challenges to growth abroad, that may not remain the case indefinitely. A host of domestic issues, including a political stage that rivals the best fiction, also countenance caution. At least once before during this recovery, these headwinds have been indictable in derailing renewed prosperity. They remain risks, but ones increasingly worthy of taming.
dsc@chandan.com
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.
