“With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market who promised these beautiful things.”
“Gateway” or “Spiky” markets are likely to lead the way out for the Real Estate asset class
Investment Context & Opportunity: Tier-1 “Gateway” Cities
Savvy, intrepid, independent-minded — particularly, contrarian — investors ought to pay close attention to real estate in global “Gateway” cities.
Gateway cities, or “Spiky” markets, can be defined as a set of global Tier-1 cities to which Prof. Richard Florida’s “Creative Class,” or even roughly, Prof. Anna Lee Saxenian’s “New Argonauts” flock.
The following metropolitan areas would constitute Tier-1 Gateway markets: New York, London, Tokyo, Bay Area (San Francisco and Palo Alto in particular), L.A./Orange County, Sydney, Miami, Toronto, Vancouver, Bombay, Rome, Munich, Paris, Moscow, Dubai, Istanbul, Sao Paulo, Shanghai, Singapore, Hong Kong.
Many of these Gateway metropolitan areas’ high-end real estate is presently under-valued by anywhere from 30 to 60 per cent vis-a-vis their historic inflation-adjusted peaks. With values of high-end real estate inventory at such dramatically low prices across many of these Gateway markets, now is the time to take some bold investment decisions.
Due to continued urbanization, these cities are on their way to transforming themselves into megapolises over the next half a decade or so. Many of these Gateway markets already enjoy megapolis status. Due to the natural limits to their expansion and the constant real estate supply-demand “cat and mouse” game, real estate prices in these markets can be expected to climb along a secular trajectory over the long-term — particularly for high-end real estate. Even in the short-to-medium term, however, these markets are likely to rebound and outperform real estate markets in smaller Tier-2 cities.
Furthermore, “network effects” or “multiplier effects” will continue to lead to a disproportionate increase in productivity in these cities compared with their Tier-2 Gateway peers (identified below). As the world comes out of the “Great Recession,” the productivity enhancements in these Tier-1 Gateway cities will get priced into the real estate asset values before (and higher than) they would in other smaller metropolitan markets. Like people, capital will be more fluid through these highly “porous” global cities. Hence, real estate assets in these Tier-1 cities will be more liquid than assets in other Tier-2 cities.
Starting now, Hedge Funds and long-only PE firms can take advantage of these opportunities by investing in landmark Grade A office space, 5-star hotels, upscale retail destinations and even marquee residential property.
Obviously, Gateway cities in certain emerging markets like Shanghai and Bombay are an exception as the real estate asset values in those markets have reached, and even exceeded, their 2008 peaks in certain instances. Infact, a credible argument can be made that high-end real estate prices are inflated in some of those emerging markets — particularly in Shanghai and other major Chinese metropolitan markets like Beijing, Guangzhou, Shenzhen, Tianjin, Hong Kong, etc.
Arguably, even “over-priced” real estate assets in emerging markets are likely to prove to be sound investments over the next half a decade and beyond. No rocket science. It is simply the crushing force of demographics that will raise price levels for virtually all forms of real estate in these centers of economic and cultural activity.
Furthermore, a small portion of this strategy could be devoted to specialized REIT’s with significant exposure to the above mentioned geographies.
A smaller amount of capital can also be devoted to higher beta, Tier-2 pool of global “Gateway” cities as well.
These would include: Chicago, Boston, Atlanta, Montreal, Rio De Janeiro, Buenos Aires, Cape Town, Melbourne, Bangalore, New Delhi, Milan, Madrid, Frankfurt, Amsterdam, Copenhagen, Stockholm, Brussels, Dublin, Vienna, Prague, Seoul, Beijing, Kuala Lumpur, Abu Dhabi, Cairo, among others.
Investment Entry Horizon:
Next 6 to 18 months would be the “sweet spot” for picking up the choicest assets without contending with bruising competition.
Investment Exit Horizon:
Next 36 to 60 months — depending on the Gateway city in question — would allow for an optimal period for healthy returns on exits.
10% to 20% annualized IRR (depending on which particular market is considered).
Roughly 5% of a diversified Hedge Fund’s total assets under management (AUM) could be a good place to start. Given the scale and scope of this investment strategy, it can absorb as much as 10% to 15% of a fund’s portfolio as the geographic diversity (North & South America, Western Europe, Russia, South Asia, Middle East, and East Asia) asset variety (Hotels, Offices, Malls, and Residential real estate) provides a natural hedge to a portfolio designed with such an exposure.
Fresh capital infusions from a fund’s limited partners would allow a fully or mostly-invested fund to expand its asset base without compromising on its investment philosophy, expected returns, risk management controls, or capital allocation/portfolio diversification principles.