Protection against a global financial crisis-style downturn may be excessively cautious

PGIM Real Estate has said that protecting real estate assets against a global financial crisis-style downturn may be an excessively cautious strategy for investors to pursue.

In its latest Global Outlook report, the manager has pointed out that many of the factors that exacerbated the GFC’s effect, including excessive leverage across the financial system, complex financial engineering and high interest rates, would not be factors in a crisis today. The manager has also stressed that many other dramatic downturns have either been milder, only affecting one region such as the Asian financial crisis in 1997, or being more sector specific in nature, as was the case in the aftermath of the dot-com crash.

“The global financial crisis was in no way a typical downturn,” write the report’s authors. “It lasted for almost two years and global real estate values fell by 3.3 percent per quarter over that period, which is steep compared to other downturns.”

“No one can say for sure what will trigger the next period of market weakness but, when it comes, the analysis demonstrates that the average capital value downturn is typically about 16 percent peak-to-trough, lasting six to nine quarters,” explains the report.

PGIM Real Estate also says in the report that the benefits from diversification can come to the fore in any new crisis, with differences in timing and magnitude of value corrections meaning that a typical peak-to-trough value decline for a global investor is just 10 percent and lasts for seven quarters, on average.

The report notes that it is important to remember that interest rates are not typically associated with downturns in the immediate term, with history showing the opposite to be true while rates are going up. As monetary policy is usually tightened during periods of fast growth, property performs well on the occupier side and elevated confidence results in lower risk perceptions, pushing up capital values via a lower risk premium.

“It is when the tightening cycle turns that real estate is more likely to run into problems,” adds the report. “Policy easing after a period of tightening implies a renewed concern about the economic growth outlook, raising questions about rental projections. Increased risk aversion leads to a rotation of capital away from risky assets such as real estate, pushing up yields.”