Jones Lang LaSalle


Capital Flows and "Happy Campers" Raymond G. Torto, Principal & Chief Strategist
About Real Estate: A Free TWR Weekly Publication
February 10, 2006 Volume 7, Number 5

rtorto@tortowheatonresearch.com
Waiting for a delayed plane at Orlando International is no fun, but it provides a chance to reflect on a myriad of conversations in which I took part, here at the MBA winter meetings and last week at CBRE's infamous private Boulders conference of major equity players. One take-away from the occasions is that lately, both lenders and investors are "happy campers!"

Participants in both meetings were clearly thankful for a rewarding 2005. Transactions were at a record volume. The only hint of concern, understandably, came with the question, "when would it end?" Well, from what I can glean from the data, and from talking with all involved, I can confidently answer that while the dollar volume of transactions will sag a bit, there will be no abrupt end this year! There is still plenty of capital out there, and more than enough reasons for transactions on both buy and sell sides!

Last year, CBRE Institutional Group's volume of sales over $20 million was $50 billion-up 76%. The volume of equity transactions over $5 million was $268 billion in 2005, according to Real Capital Analytics. This was up about 50% from the previous year and up $164 billion from 2002 levels.

Is $268 billion a lot of transactions for a major investment asset class? One way to think about it is to estimate the turnover ratio. If we assume that the institutional real estate universe is roughly $4 trillion[1] , then we have about a 7% turnover ratio for real estate. Compare this to stocks and bonds. The capitalization of the stock market is about $15 trillion and a historical estimate of turnover on an annual basis is about 300% to 450% depending on the year.[2] The size of the bond market is about $25 trillion, and turnover there is around 450% per year!

By these comparisons, we have a long way to go to reach "liquidity." And while the higher transaction costs in real estate will always dampen the turnover ratio, it is reasonable to suggest that the current transaction volume could easily double in the future. A 15% or higher turnover ratio is not out of the realm of possibility.

At the CBRE Boulders event, Jeff Dohrmann of IREL presented the results of the annual Kingsley survey of how much the institutional money "lords" will be allocating to real estate in 2006. The figure below shows the bottom line on institutional plans. Another $59 billion is allocated to real estate for this year. Add to this the un-invested funds of 2005 and earlier and the sum rises to over $100 billion of institutional money waiting entrance into real estate. This is 40% of 2005's transactions.

Expected Capital Flows to Real Estate

We have shown in these weekly commentaries, and in our analysis for clients, that as prices have risen over the last few years, the yield advantage that real estate once had relative to other asset classes has been competed away. Further, we have now entered a time of diminished expectations. So why is institutional capital still flooding into real estate?

Diversification and Alpha! There is no doubt anymore that real estate is a great asset to have in a portfolio of investments for its diversification benefits. One study has shown that putting real estate into your portfolio will reduce the risk of the portfolio by 174 basis points without any diminishment of returns. This is the last "free lunch" that I am aware of! Further, the evidence is strong that only in real estate can investment managers beat the market on a regular basis--this ability is commonly referred to as Alpha.

I have every reason to expect that come next February, my friends at MBA and the CBRE Institutional Group will again be celebrating a good year! I am so confident that I've insisted that next year's restaurants be more expensive, and their dinners more extravagant!

[1]Estimates vary on this from $3.5 trillion to $4.5 trillion.

[2]I am indebted to my friend Randy Mundt from Principal Investors for sourcing this information for me. In addition, we have adjusted the turnover ratio reported here to reflect only one side of the transaction, so it is comparable to the real estate numbers. For the bond ratio we subtracted the Treasury market since much of this turnover is tied to hedging strategies.

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