Now is the time for researchers to come to the aid of the real estate asset class

Alan Patterson MSc FRICS, VARE Consulting Ltd

In the wake of the dot-com excesses of the early 2000s, regulators belatedly started to recognise that equity market analysts had, in some instances, become part of the sales operations of the stock brokers who employed them. As part of the subsequent reforms, analysts were required by US regulations to certify – under penalty – that they were not remunerated based on their buy/sell recommendations. The certification wording was crass, but the objective was right: ensuring that clients received impartial advice.

Such regulations did not, however, apply to the direct real estate market and there has been no oversight of the output of the researchers employed by the agents and fund management houses. While some fund managers did implement a system of deferred bonuses, mimicking those of the banking sector, these typically did not apply to researchers who were not – strangely – recognised as part of the client advisory function. In a ‘bull’ market, such as we have seen for real estate in most of the last 10 years, it is perhaps inevitable that researchers came under pressure to support the transaction activities of the firms and assist with product marketing.

This has been most evident in the retail investment sector, when some researchers were apparently unwilling to caution against the pricing of the assets despite the obvious extremely poor prospects for the high street and shopping centres. At the extreme, we even saw some researchers suggesting that the sector was positively attractive.  More generally, while the asset class was being promoted, the quoted property stocks’ pricings were signalling that the equities markets simply did not accept the valuations of their portfolios. The ensuing gap in pricing was generally ignored by the researchers.

Of course, few investors foresaw the implications of the current coronavirus crisis and, no prices (adequately) reflected the risk of such an event.  But there was little cushion in the pricing to protect against anything other than the (generally optimistic) outcome built into the appraisals/projections. Almost all economists accepted that there was still a business cycle and most accepted that an economic downturn, while not inevitable in the short-to-medium term, was a distinct possibility. While the impact of the current coronavirus restrictions on the economic output in the western world will almost inevitably trigger a subsequent deep recession, there is an argument that they have only brought forward something was likely to happen soon anyway.

It is still too early to say what will be the full effect that the recession will have on property values, but we can take a view from what is happening to the quoted real estate sector. For many of the larger REIT stocks, prices have hit not just cyclical lows, but historic lows. One interpretation is that retail sector assets are approaching a zero value. This may have been an over-reaction, but the direct market cannot continue to ignore such messages.

It is very likely that the reaction by fund management real estate clients will be similar to that expressed in the aftermath of the 2009 downturn and there will certainly be some embarrassment by researchers that they were not, at least, rather more circumspect about the advice that they were giving. Yes, the coronavirus may have shifted sales from the high street to the internet and increased the amount of home working, but these were trends that were already in place and the virus will have largely – once the restrictions are removed – just accelerated the trend.

The reaction of the direct real estate markets will undoubtedly be one of investors refusing to sell at the prices that purchasers are willing to pay. Liquidity will dramatically drop. Reflecting that, redundancies in the real estate industry are actively being considered and, in some instances, already being implemented.

Now is the opportunity for the real estate researchers to redeem themselves. By making the case for appropriate pricing levels to reflect the medium and long-term prospects for property, they can assist both vendors and purchasers to converge on pricing. Obviously, few researchers will agree on pricing levels, but merely establishing rational values will stimulate debate and lead to investors taking more realistic approaches. By doing so, they will be bringing forward the inevitable hit on pricing but, this acceleration of the process will benefit their clients, their businesses and the industry as a whole. Managers of agencies, advisors and fund managers need to give them the scope to do this.

The good researchers will attract clients for their businesses, just as equity analysts attracted clients for the stock broking firms, at least before the advent of Mifid II. They will becoming valuable assets to the businesses that employ them – far more valuable than they would be as salesmen.

Let’s hope that this happens and we can see the maturation of the real estate asset class.