Driving with the rearview mirror: CRE needs a new roadmap for recession risks
Navigating the post-pandemic economy is turning out to be hard. Ahead are hidden hazards, sharp corners and unpredictable oncoming traffic.
UK inflation rose to 9.1% in May, according to data released today. In the U.S. it is 8.5%, both at 40 year highs and both expected to grow. Energy prices are soaring, and growth on both sides of the Atlantic is doubtful: U.S. first-quarter growth was 0.1% whilst UK GDP fell by 0.3% in April.
Nobody expects a sudden recovery anytime soon. Central banks have a choice of raising interest rates and stymying growth further, or letting inflation rip.
All of which poses a problem for commercial real estate seeking data to drive decision making. It boils down to: Which direction is property looking for its journey into and out of recession, forward or back?
Rearview Or Forward-Looking?
Talk to big money — or even midsized money — and investors are already living in 2024. They are poring over myriad economic data sets and forward-looking indicators, trying hard to spot trends before they are trends. They are living life, literally, ahead of the curve.
Then talk to agents and many developers. They tell you about five-year averages, historic take-up, the micro-history of leasing in this location or that. Their data sets are narrowly focused on real estate and point firmly backward — last quarter, last year, even last decade. They are driving with the rearview mirror and when it comes to the future, there’s no numbers, only hunches.
When a looming recession means the future begins to feel very different from the past, the reliance on traditional market data can cause problems.
The property industry has long relied on backward looking data. “Traditional metrics such as historical market activity and economics have always been relevant for real estate decision makers," BNP Paribas Real Estate Head of Research and Insights Vanessa Hale said.
"Even to this day, where the previous impact on markets or capital flows can be examined to draw parallels when assessing current investment opportunities or risk factors."
Agents have historically been relied upon to provide historic market data, which made sense as they tended to have the market coverage of transactions and deals readily available and, of course, the ‘on the ground’ knowledge and insights to back it up, Hale said.
“This is what always happens in a market turning point, with some thinking in terms of yesterday's pricing and liquidity, and others looking forward," M&G Real Estate Head of Investment Strategy Jose Pellicer said. "And the first effect is on liquidity because the prices sellers are prepared to accept are not the same as those the buyers are offering.”
The early warning signs of a mismatch between forward-looking and backward-looking data comes in the form of bid numbers, Pellicer said. “It’s only anecdotal, but the noise we’re hearing on how many underbidders there are gives you an idea of where the market is going,” he said.
Pellicer said this happened in 2010 and again in the 2013 euro crisis, and is part of what some observers call the “normal malfunctioning” of the property market. And it is not all bad news. Gaps between what buyers and sellers expect are much-prized spaces in which hopes can flourish and shrewd bets pay off.
It's Behind You
Tom Wallace is the founder and chief executive of Re-Leased, whose commercial property management software yields interesting data on who pays rent, how often and how much. During pandemic lockdowns Re-Leased data helped landlords and policymakers assess the state of the market.
Wallace said agents and developers with strong local knowledge have a feel for a market, “which means they can make a good guess about the future”. But institutional landlords, without this local touch, turn to wider data trawls in the search for comforting information about what’s coming next. “And this creates a tension because they come up with different answers — and that in turn creates opportunities, because they can’t both be right,” Wallace said.
Wallace even goes so far as to suggest too much reliance on forward-looking data could be dangerous.
“Taking bold moves on forward-looking data comes with a risk, because the story isn’t written yet," he said. "Think back six months when we all thought the market was coming nicely. And now today that feels very different. Too much is in flux to rely too much on forward-looking data.”
Don't Look Back In Anger
Yet driving real estate strategy on the strength of historic data has some serious downsides, downsides now exercising the minds of property number-crunchers.
“More holistic intelligence is required to support current day investment decisions, and examining socioeconomic trends has become a staple in the investor and developer decision making process,” BNP Parisbas’ Hale said, tipping her head to the firm’s Next X data tool and its alternative metrics.
Re-Leased’s Wallace is also working on new data tools to meet this need. “Our data shows what is happening right now, but as it stands today it doesn’t tell you much about the future, but that’s something we want to bring in, using other data sources. You need a picture of the future just as you need to know where you are today,” he said.
The trouble is that new forward-looking data sets are not coming quickly enough to meet a rapidly changing economic situation. In the meantime old habits are taking control — and the oldest and most dangerous is to assume that property is all about capital values.
Matthew Richardson is the founder and chief executive of Income Analytics, the MSCI and Savills-backed data firm that provides investors with global rental default risk measures at tenant, asset, fund and portfolio levels.
“Elements of the property industry are a little bit stuck on data looking backwards, and at the kind of inflexion point in the economy we are at now, that can feed into an over-reliance on valuations, which of course are carried out with backward-looking data,” Richardson said. “Valuations are often on the back of comparables from six or 12 months ago, which are now seriously out of date."
Richardson said the property market needs to learn to analyse assets in the same way that debt and equity markets look at value, “modelling the future based on assumptions about the next five years, not what happened in the last five years”.
In particular, this means treating rent (and hence yield) as the main focus, and not capital values. Richardson argued a lease is a kind of borrowing arrangement — the tenant gets space (the principal) in return for rent (interest) and the landlord gets the principal back at the end. And if you think of property income as a kind of debt, everything becomes clearer. “What matters is you focus on default and the risks of default in the future — how likely a tenant is to go bust — and in a recession we know some business flourish and others don’t,” he said.
“What killed the market in 2007/08 was that everyone looked at capital values and no one looked at the cash flow underlying those values — the capacity to pay rent — and that evaporated, and so nothing was worth what they thought it was.”
Keep your head straight and eyes fixed on the road ahead, because what’s coming toward you matters most, Richardson said.
In Richardson's view, the juggernaut heading property’s way is the end of quantitative easing, as signalled by the end of the super-low interest rates that came hand-in-hand with it. “We’ve created a zombie economy with a load of businesses paying rent who wouldn’t normally survive,” Richardson said. When those businesses collapse there will be a high property price to pay — and no amount of historical take-up data or rental curves will help you spot that moment.
What commercial real estate needs is a big think about the data it values. “Property has become a global asset class but the analytics hasn’t caught up,” Richardson said.
Driving Conditions: Poor
To look ahead into the future, or back at the past? Front-facing or perpetually rearview glancing?
So long as parts of the market are looking in different directions there will be tensions, tensions most apparent in the pricing mechanism, said Walter Boettcher, chief economist at Colliers, a veteran of several recessions.
“Looking back feels stable, looking forward feels more uncertain, although the smart money is looking past short-term volatility,” said Boettcher, who is still (just about) happy with the idea that inflation is a short-term phenomenon.
“But there is a mismatch in expectations, we’re at an awkward moment for those tracking yields and rental growth expectations to determine the viability of investments,” he said. “We’re at a turning point where expectations are heightened, and it all depends how high interest rates go and the effects on property pricing. The question is should investors be defensive now, or be opportunistic ideally without leaps of faith.”
Boettcher’s conclusion — for now — is that looking forward probably offers more insight than looking back. But he’s far from certain. Because who knows what’s hurtling toward us?
The Forward-Looking Data Sets You Need To Bookmark
Avison Young Global Director of Insight Nick Axford pointed Bisnow to the forward-looking indicators commercial real estate needs to watch.
Public transport data. “It’s interesting how we’re seeing higher levels of use at weekends, more or less back to pre-Covid levels, but not so much on weekdays,” Axford said. If more people come into town, there's more economic activity. If less, less. London data is here and New York data is here.
Energy and fuel costs. Energy costs were the first to rise, and presumably will be the first to fall once the economy recovers its balance. UK gas and electricity pricing is here and for the U.S. the numbers can be sourced by linking from here.
Job vacancy levels. “This is almost more important than employment or unemployment levels, because it tells us how competitive the market is and how much employers may have to bid up wages,” Axford said. The latest U.S. data is here and the UK data is here.
Long-term inflation expectations. “Ben Bernanke, the former Federal Reserve chairman, once said that the most important thing keeping inflation down was that inflation was down — it set people’s expectations. If long-term inflation expectations rise, and they are elevated, but not worryingly so, then we have a crucial clue to the next three-to-five years,” Axford said. You can find a digest of UK expectations here and a selection of U.S. numbers here.
Read the full article on BISNOW.
Income Analytics welcomes new team members
Michiel Foekens has joined Income Analytics as Director of Sales to help drive our exciting and ambitious growth plans.
Income Analytics Launches Income Risk Reports “T200”
April 27th 2023, London. The Income Analytics (INCANS) UK T200 report shows hospitality sector tenants are less likely to default than 12 months ago. The sector is not out of danger, with average rates still below the UK all sector average, but there is clear improvement. Pubs & restaurants recorded the largest positive change across all sectors.
Real estate data veteran Mallinson joins Income Analytics
February 6th 2023, London. Income Analytics (INCANS) announced today that Simon Mallinson has been appointed as its Chief Operating Officer. Established in 2020, INCANS is focused on helping clients quantify tenant income risk and minimise future losses. “We are excited Simon Mallinson has joined us as we enter the next stage of our growth” said Matthew Richardson, co-founder and CEO of INCANS. “Simon has a wealth of global experience delivering real-time, actionable data to real estate professionals and is the right individual to reinforce INCANS growth”.
Retailer health check: who will be next after Joules?
Great to see our tenant default analysis feature in a recent piece by React News.
How NewRiver is stress-testing its portfolio
In a recent article run by EG, Pui-Guan Man looks at how real estate investors and owners are using INCANS® scores to help quantify the future cashflow at risk caused by potential tenant defaults.
UK CRE investment markets go "income only" as yield gap over bonds disappear
Since 2008, commercial real estate has enjoyed an unprecedented bull run in terms of capital value growth. That charge is now over. Today’s economic realities mean that the returns from real estate investments are likely to be “income only” for the foreseeable future. Under such conditions investors need to shift their attention to the quality and duration of their rental cashflows.
Logistics tenants are under pressure while retail woes continue
Businesses in the logistics sector are the highest risk tenants, while those in healthcare and education present the lowest risk. These are the findings of the INCANS Top 200 Averages for Q2 2022. The ratings, created by Income Analytics, give real estate professionals a likelihood of tenant failure by using advanced statistical modelling. The lower the score, the higher the risk of default. The following are most challenged sectors using data to the end of Q2 2022:
Risk of tenant default higher in logistics than retail or leisure
New data on tenant default risk from Income Analytics has underscored the vulnerability of many logistics occupiers.
Income Analytics partners with EG Radius to supply tenant and asset risk solution for the UK real estate industry
Matthew Richardson, Founder and CEO of Income Analytics, said: “We very much welcome the opportunity to work with EG in providing a “best in class” tenant risk solution to their clients. It is an area of the market that has been neglected for far too long, and recent events have only confirmed the need for landlords to better understand their tenants and the challenges they face.” "The INCANS® Scoring system was set up to answer a simple question – “What is the % probability that a tenant will default during the term of their lease?” We are delighted to be able to offer this capability alongside EG’s extensive data sharing platform.”
Income Analytics releases industry market averages to the platform
We are pleased to announce the product release of our Top 200 Industry and Property Sector Averages. This is the result of months of analysis by our research team, bringing this data to life for the first time.
New PDF report release
We are delighted to announce that we have released a new set of tenant, asset and portfolio level PDF reports. These will be available on the INCANS platform from Monday 7th February 2022 and have been developed in response to client feedback over the last 12 months.
MSCI on calculating the risk to real estate income
In this month's PERE publication René Veerman from MSCI Real Estate writes about how Covid has shown the need for data tools that enable investors to understand the risk that tenant defaults pose to cashflows and hence why MSCI Inc. has invested in Income Analytics and is providing access to the INCANS tenant income risk dashboard to its global client base.
MSCI: "Understanding Tenant Default Risk with Income Analytics"
Check out this fantastic new video by MSCI Real Estate MSCI Inc. on our partnership and 'how and why 'this is such an exciting and important partnership for the global commercial real estate industry.
Welcome to new starter Lucy Baker
We are excited to announce that Lucy Baker has joined Income Analytics as our new Account Manager, she will be working closely with all clients as well as our Sales team.
"Why The UK's Supply Chain Crisis Could Be A Mega-Headache For Landlords"
Exclusive data provided to Bisnow by Income Analytics shows it likely means more bad news for landlords, some of whose tenants may now fail to make it through the vital pre-Christmas trading period.
Real estate’s income risk in the wake of COVID-19
In this blog by MSCI, the relationship between the MSCI UK Indices and the INCANS scores is analysed delivering some fascinating insights
"Income Analytics Aiming to Shake Up Real Estate Valuation"
Property Week reports
Power of Data Podcast
Matt Richardson, CEO Income Analytics, is interviewed for the Dun & Bradstreet Power of Data podcast series by Nick White, Head of D&B Accelerate.
"Why We Need To Talk About Your Risky Tenants"
The founders of a new proptech venture that has just won backing from MSCI and Savills said UK commercial real estate needs to rethink its approach to cashflow.