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Thursday, March 17, 2011

Where Are the Contrarian Investors?

By Amy Erixon (Toronto)

Investors everywhere seem to be bemoaning the fact that pricing for prime properties is exceptionally competitive, in many instances it appearing to be well ahead of local property market fundamentals.

But this really should come as no surprise. According to the recent IPD (International Property Databank) sentiments survey of contributing global investors, more than 90% of respondents are primarily focused in 2011 on making core investments, a similar percentage seen in 2010 and 2009. By comparison, in the years leading up to the crash, investors were pursuing a variety of strategies, endeavoring to match risk and return characteristics and in doing so achieve attractive returns. The fact there is a growing sense that the focus on core properties is be pushing valuations into a range that might be disappointing in the medium to long term begs a couple of questions.

First, how do you identify the crossover point where a trend is played out and loses momentum? Second, what is the appropriate long term valuation spread between bread and butter middle market investments and large scale investments in the largest cities? And lastly, why are value creation strategies failing to attract significant interest from global investors?

We are beginning to hear stories about property flips in the most coveted markets, with reports of 50% or higher gains on properties held a year or two where no improvements have been made. This will likely attract enhanced investor interest in those same core markets, supporting the current wave of relatively high valuations in the near term.

It's widely demonstrated that prime properties offer stability of returns and capital values that are difficult to replicate in other investments. The steady demand for these investments (capital push) from large global institutions has insured that this tenet has been a self-fulfilling prophecy. But as valuations slide into ranges that fall far below most insitution's actuarial cost of capital, it is helpful to recall that capital stability is only one of the attributes that savvy investors have enjoyed from property investments in the past. Outsized capital growth is also available at specific times in the recovery cycle and we might be at the inflection point of that strategy for a broad range of property types, locations, sizes and quality characteristics.

Well timed and well conceived projects will perform in the long run. It is equally true that poorly timed projects and existing properties with reposition potential represent outsized return opportunities for investors and managers with the expertise and patience to tease out the value spread available for doing the work to move these investments to core.

It's little wonder that between bumpy recovery statistics and ongoing political and geological shocks investors continue to shun risks. But does that mean that this is the optimal time to take measured risks in our property investment strategies?

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