Property is cyclical… investors need to know which part of the cycle they are in, regardless of the geography

PM Capital

PM Capital

After the GFC, or the ‘great recession’ as many in the US refer to the events of 2008, PM Capital was looking for value opportunities there. The collapse in residential property in a number of markets was stark. Our observation was there was excellent value in a number of markets, particularly in Nevada around Las Vegas. Purchasing individual properties was too complex and too expensive so we looked for a listed vehicle that could gain exposure to the markets we liked. Consequently we invested in the Howard Hughes Corporation, a major developer and land bank holder.

More recently, but in a similar vein, my colleagues and I researched the European property market and began investing in property there in late 2013. Our focus was the Irish and Spanish commercial property markets, which seemed to be replicating the US experience, with deeply depressed markets and assets selling well below replacement cost. The fall in property values was across the board however we believed that prime commercial real estate, in particular, over-corrected. With rents at their lows and yields at their highs, asset prices were down between 40-70% from their peak values. The market was dysfunctional due to new construction being virtually non-existent. Developers were either bankrupt or severely constrained by the banks, due to insolvency. This, coupled with properties being valued below their replacement cost, led to a great investment opportunity.

My most recent trip to Europe this year confirmed that the Irish commercial real estate market was firmly back on its feet. There has been a substantial rise in property prices and banks are now willing to lend against commercial office developments. This is leading to a surge in office construction which is likely to temper asset price growth. Whilst we think there is room for further growth, the risk return has now contracted and we have reduced our positions in Irish commercial real estate across the portfolios.

Despite our post-GFC foray into US residential we tend to find that office and hotel property in open, trade exposed economies like Ireland perform best in the initial stages of a recovery, given the high level of international demand. Generally our observation is residential and retail assets perform better once the recovery has firmly taken hold, given they rely more on domestic demand.

This experience and mindset led us to reinvest capital out of Irish commercial property into the Irish residential market. Our vehicle for this move was the 2015 IPO of a newly created homebuilder, Cairn. The property crash in 2008 left all the major Irish residential developers bankrupt resulting in housing starts falling 90% from a peak of over 80,000 units per year to around 8,000 units in 2013. After nearly eight years of limited new building the residential market is now undersupplied, with demand driven by the twin engines of a growing population and 3% employment growth. In addition to this dynamic, well located land within 15kms of the city centre is selling for 70-80% below peak values. The fact that it is now substantially cheaper to buy versus rent in the prime residential areas where Cairn has been buying zoned land gives them a great runway for future profitable sales.

Spain on the other hand has not seen the same bounce in property prices, although to us it looks like it is at the same place Ireland was two years ago. This should lead to a strong property market recovery over the next few years. Our conclusion from our visits to Spain over the last number of years is that it has successfully restructured its economy, lowered its cost base and now looks more like Germany with a competitive export sector and a current account surplus. We are now seeing unemployment falling, asset prices rising, and businesses linked to the domestic economy performing well once again. Consequently we are focusing on investing in companies in the hospitality and office sector in the first instance. However such is our conviction regarding the Spanish economy’s positive outlook we have also invested in a Spanish retail mall specialist.

We continue to believe that the risk return from exposure to overseas property markets outweighs exposure to Australian property. Australian residential property has had a wonderful run over the last number of years due to bottlenecks in supply but construction is now increasing rapidly, which may temper asset prices growth. In the commercial sector prices appear high with rents at the peak, stagnant demand and increasing supply. Consequently we view investment opportunities in property as being skewed to overseas markets.

This article was originally published in Investor Daily


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