Download Introducing the Alpha Matrix - Alpha Investment Partners Limited

Introducing the Alpha Matrix
At Alpha Investment Partners (AIP), we evaluate the real estate market from two perspectives
– space market and capital market. Please see Figure 1. The space market refers to the
attractiveness of the physical real estate market. We analyze factors that drive tenant demand
and supply of space, the relative demand-supply market dynamics and use them to draw
conclusions on prospects for rental growth, occupancy rate, and the general outlook for the
space market. Some of the factors we look at include business and economic confidence
indicators, social demographic trends, impact of government policies, real estate trends, and
so forth.
The capital market refers to the attractiveness of investing in a particular real estate sector
relative to historical yield trends, borrowing costs and against other investment alternatives.
Other factors that are considered before forming a perspective include an analysis of the
weight of capital looking for deals against the stock of properties available for purchase,
impact of government policies, tax policies, and other alternate routes for selling or
participating in the real estate market such as REITs or securitization.
Our assessments are based on quantitative analysis in so far as the relevant data are available.
In cases where data is lacking, we would rely on qualitative assessments and substantiate it
with anecdotal evidences from our local network.
Space Market
Demand
• Market Size &
Growth
• Absorption
• Affordability
• Government policy
• Social demographic
Capital Market
•
Buyers
Supply
•
Sellers
• Current stock
• New supply
•
Borrowing cost
•
Funding alternatives
•
Valuations
•
Property yields
•
Interest rate
environment
•
Government policies
• Competition
• Land supply
• Product trend
• Government policy
The Alpha Matrix is a graphical representation of our space market and capital market ratings.
Please see Figure 2. The horizontal axis (or X-axis) on the Alpha Matrix measures the space
market rating, and the vertical axis (or the Y-axis) calibrates the capital market rating.
Alpha Matrix - Singapore Properties
Buyer/Tenant
Quadrant
-5
SPACE
Seller/Tenant
Quadrant
Office
Buyer/Landlord
Quadrant
+5
0
C
A
P
I
T
A
L
MARKET
M
A
R
K
E
T
-5
Retail
+5
Seller/Landlord
Quadrant
Residential
A rating scale ranging from –5 (most unfavorable or unattractive) to +5 (most favorable or
attractive from buyer’s perspective) is used in the Alpha Matrix. Space market is rated using
occupancy and rental growth. Capital market is rated using net rental income yield and
borrowing cost. The rating reflects the current state of the key variables relative to their
historical cycles. It is calibrated using the mean and standard deviation of its historical trends,
with the mean indexed at zero.
The right side of the X-axis reflects that the space market condition is favorable – i.e. the
occupancy rate and rental growths are higher than their respective historical mean. It is a
“landlords’ market”, as the space market is tight and the landlords have the upper hand in
dealing with their tenants. Conversely, the left side of the axis reflects a “soft” leasing market
or what we call a “tenants’ market”.
The upper part of the Y-axis reflects that the real estate market is attractive from an
investment perspective, looking at it from the buyer’s viewpoint – i.e. rental yield less
borrowing cost is attractive compared to the historical mean. This is also the part of the
market cycles where typically there are more sellers than buyers, and investors can take their
pick of properties to invest in. It is what we will classify as a “buyers’ market”. Conversely,
the lower part of the Y-axis reflects a “sellers’ market”. This is the stage of the real estate
cycle, usually near the top, where there are more capital chasing deals.
As such the matrix can be divided into four quadrants as follows:
•
The Buyer/Landlord Quadrant (upper right of matrix)
This quadrant reflects a favorable space market and an attractive capital market
situation. An investment falling in this quadrant offers attractive investment
opportunity. In more efficient markets where there are no barriers to entry of capital,
this situation may not last very long, as new buyers enter the market to take advantage
of increasing rentals and favorable buying conditions.
•
The Seller/Landlord Quadrant (lower right of matrix)
While the positive space market rating reflects a favorable physical supply-demand
dynamic, the negative capital market rating implies that it is “expensive” (relative to
the historical experience) from the buyer’s perspective. Undervalued off-market
deals in such markets may be worth considering.
•
The Seller/Tenant Quadrant (lower left of matrix)
This quadrant reflects a market that is probably oversupplied and
“expensive” (low rental income yield and/or high borrowing cost)
perspective. The circumstances are unattractive for investment.
efficient markets, supply should stop and yields move up to
investment conditions.
•
The Buyer/Tenant Quadrant (upper left of matrix)
While the negative space market rating portends a poor outlook for occupancies and
rental growth, the market appears to be attractively priced with high rental yield
and/or low borrowing cost. The circumstances warrant closer monitoring for market
turnaround opportunities.
at the same time
from the buyer’s
Again in more
reflect the poor
While the quadrant in which a real estate sector currently falls into will provide a good
indication of its attractiveness, the expected trend for the space and capital market indicators
is also critical to the investment decision. AIP, together with Associate Professor David Ho
from the Department of Real Estate in the National University of Singapore, has developed
quantitative models to forecast the outlook for the markets in which we are active.
The models are essentially regression techniques, that are stock-flow and error corrected as
well as expectation augmented, and are deployed for the purpose of forecasting selected real
estate market indicators of interest. The arrow used in the Alpha Matrix shows our forecast of
the space market and capital market in 6 to 12 months time ahead. The direction of the arrow
becomes an important consideration in assessing the attractiveness of a market.
The four broad directions are:
•
Eastward
An arrow pointing east means that the space market is expected to improve (i.e.
higher occupancy and/or rental growth) in the next 6 to 12 months. Generally, it
suggests good prospects for income growth or stabilization of a falling rental market,
and is a positive signal on investment opportunity.
•
Westward
Conversely, Western direction reflects expectation of a weakening space market and
possibly, falling rents. It is a sign to be cautious. One would avoid the market if
there were no other mitigating factors. Owners will take a hard look at their assets to
evaluate whether they are worth holding on to. At the very least, an aggressive
leasing strategy might be appropriate ahead of an expected softening of the leasing
market.
•
Northward
Northern direction means that the capital market is projected to become more
conducive for buyers (i.e. improve in rental income yield and/or cheaper borrowing
cost). It suggests to investors to be patient when bidding for deals, and perhaps even
consider monitoring for better buying opportunities to come.
•
Southward
Southern direction indicates that the capital market is expected to become less
attractive for buyers (or more attractive for sellers). It may be a signal for buyers to
be a bit more aggressive in meeting asking prices, as valuation will generally get
more expensive.
Where possible, our indicators are based on quantitative assessments, taking into account
historical trends. We may also need to take into account any recent structural shifts that are
not reflected in the historical trends. AIP suggests that it will be meaningful to overlay
subjective assessments on top of the Alpha Matrix in making investment decision.
For illustration purposes, Figure 3 is a chart on the historical space market rating of the
Singapore office sector together with its rental trend for the period from 1995 to 2002. It
shows a strong correlation between the two series. The space market rating seems to be able
to give a good account of the rental situation. It also appears to lead rental trend by a few
quarters.
Figure 4 is a chart on the capital market rating and the price trend for the period from 1994 to
2002. It shows that the capital market rating is a good reflection of the price situation –
periods with positive capital market ratings tended to coincide with periods of down cycle for
capital values and vice versa. However, the capital market rating per se does not predict
capital value movements as the latter also depends on rental movements, besides that for
yields and borrowing costs. A positive rating merely suggests that buying conditions have
improved but the actual recovery in capital values may not eventuate until rents start to grow
again. This particular shortcoming of the capital market rating also highlights the need to
adopt a holistic approach, that looks at both capital and space markets when assessing
attractiveness of real estate markets for investment.
We hope that the Alpha Matrix will serve as a useful additional lens for investors when they
evaluate real estate markets.
SING APO RE O FFICE SECT O R
5
110.00
4
100.00
3
2
90.00
1
80.00
0
-1
70.00
-2
60.00
-3
50.00
-4
-5
40.00
S pace M arket Rating (LHS )
Rent Index (RHS )
SINGAPORE OFFICE SECTOR
5
110.0
4
100.0
3
90.0
2
1
80.0
0
70.0
-1
-2
60.0
-3
50.0
-4
-5
40.0
Capital Market Rating (LHS)
Price Index (RHS)