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Monday, February 28, 2011

The Importance of Expectations

The recently released Canadian Investment Property Database ( reported average annualized returns for Canadian property in 2010 of 11.1%. The median anticipated return according to IPD's survey of participants was a mere 3.9%, an underestimation of 720 basis points.

What is behind this spirit of caution, and what are the implications of being so conservative? Years ago, when I was in grad school, my economics professor Lester Thorow, used to advise his students, "if you are going to guess, be wrong on the downside, that way no one will be mad when things turn out better". But a miss like this makes one wonder, what are the consequences of such conservative behavior? Would we have behaved differently had we known the property markets would be so much stronger?

It is human nature to be cautious when the markets are still being buffeted daily with new sources of uncertainty. But property markets with intrinsic valuation stabilizers such as significant barriers to entry, high replacement costs and long term leases that enable them to ride out many of the vicissitudes of shifiting political and economic winds are fulfilling their role in multi-asset portfolios. Canadian markets, in particular have been resilient, maintaining low vacancies and some of the developed world's highest cap rates. If anything, confidence in continued strong performance from Canadian property markets against this backdrop should be a given.

As the year ahead unfolds, property markets look attractively positioned for recovery in a growing number of locations. A plethora of domestic and off-shore investment options look to be coming into the market to meet the demand of returning capital and existing investors frustrated by low returns on alternative investments. Liquidity is improving and the ongoing recovery, although spotty and uneven is likely. Some of these products will be very well timed, and others not so much. The key will be to discern better than we did last year, which markets/sectors are poised to pop.

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