(MENAFN- Khaleej Times) With the Fed rate hike at the December FOMC, the era of easy money and property bull markets is now over. The Federal Reserve responded to the failure of Lehman Brothers amid the global credit crisis in 2008 by slashing its overnight borrowing rate to near zero and expanding its balance sheet from $900 billion to $4.5 trillion. This meant a collapse in US dollar interest rates that led to a multiple year boom in commercial property.
However, with the Fed rate hike at the December FOMC, the era of easy money and property bull markets is now over. Interest rates have surged in the US, Europe, Asia and emerging market. The $2 trillion global bond market meltdown means interest rates will continue to rise in 2017 and 2018 as Donald Trump's fiscal stimulus raises inflation risk at a time when the US economy has achieved full employment. This means the Yellen Fed has no choice but to raise the overnight borrowing rates thrice in 2017 and thrice in 2018. This means a disaster for leveraged property markets, particularly in US dollar pegged markets such as the GCC and Hong Kong.
When bond prices tank, property prices follow. This is most true in global commercial property, where values are inflated by the worldwide scramble for yield in a zero interest rate milieu, as the central bankers used the alchemy of "quantitative easing" to print $12 trillion in high powered money. Yet as bond yields rise on Wall Street and interest rates rise, this leveraged asset class becomes toxic for investors. The world is now vulnerable to a swift, brutal fall in property prices as US interest rates continue to rise and global capital abandons Europe, Asia, China and the Gulf to seek a safe haven in the US at a time of rising global geopolitical and banking risk.
Many property markets worldwide are driven by offshore hot money flows, speculative capital flows financed by high octane bank leverage, not any intrinsic metrics of fundamental value. London, New York and Hong Kong office values have surged beyond their 2008 peak. Dubai office rents are the highest in the Middle. A 1,500 square yard home in the Karachi suburb where I was born (Defence) costs $1.2 million ten times its cost a decade ago. These values are inflated beyond any criteria of fundamental value.
Of course, negative interest rates in the German government bond market anchor five per cent yields in Berlin, Frankfurt, Munich and Hamburg. German office property has compelling value because the inflation adjusted yield reflects fundamental value in the EU's largest economy. Yet this argument no longer holds in US dollar or US dollar pegged markets, where the yield gap is narrowing.
Private equity funds have dumped $20 billion in global commercial real estate. The smart money in global finance is obviously heading for the exit, while the dumb (leveraged dumb) money is lured into overhyped, overpriced new "iconic" new supply developments.
Shopping malls and office buildings are the two largest segment of the US commercial property real estate investment trust (REIT) market. However, the average office sector yield of 4.8 per cent offers little room for compression as interest rates rise while shopping malls are dinosaurs in a world where retail moves into the Digital Age with a vengeance.
In fact, e-commerce's meteoric growth has hugely benefited industrial warehouse/urban distribution centre values. Healthcare has an attractive sector yield at 6.5 per cent but Trump may well repeal Obamacare and wreck havoc on the value of healthcare REIT. The high sector yield reflects higher risk even though the ageing baby boom generation, the biggest, wealthiest cohort in US history, is a demographic gold mine.
The millennial generation has little interest in homeownership, having seen their parent's trauma in the crash of 2008-09. So Blackstone Group accumulated a $10 billion portfolio of single-family homes for rental incomes, now filed for an IPO. The future pay may lie in niche sectors like data centres and self-storage.
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