Where next for global real estate?

With US dollar interest rates up in the past year, and seemingly heading higher, international real estate markets are gradually slowing down.

But real estate is not like the stock market, up one day and down the next. Instead this sector is more like an oil tanker, which takes a long time to stop and some time to get going again.

The danger for investors is that real estate can appear calm while beneath the surface the tide is turning. Particularly at the top of a market there is no end of tempting projects and indeed, an abundant supply of property may be the first sign that things are not looking so bright.

Slow property sales

Hence the longer selling times for properties in the US and some UK locations over the past year tell a meaningful story. There are fewer buyers around and more sellers, and thus price rises have ground to a halt and even a few bargain distressed sales have been noted.

A Spanish real estate agent on CNBC Europe this week pointed to 2% rental yields in Spain as a solid indication that this was not a market for buy-to-let investors, and was only suitable if you wanted to move to Spain to live in a property for a long time. Indeed, the squeeze on rental yields around the world should surely be a warning to investors.

Rental yields are the property equivalent of price-to-earnings ratios for companies. So if you buy on a 2% yield this means that it will take 50 years of current rental income to pay for the property. Given that interest rates are rising and that a US bank deposit account will pay more than double this amount, this hardly appears a very good deal.

Wild overvaluation

Surely this kind of rental yield suggests the property is wildly overvalued, and that there is a severe risk of capital depreciation. For the only justification for buying on such a low yield would be that either rents were about to go up, or house prices would actually rise further.

What has happened in global real estate is that a long period of low interest rates has gradually allowed prices to rise way beyond anything sensible in comparison to rental yields.

This is a dangerous position for investors, and if global inflation picks up and interest rates rise further then real estate is going to suffer a big squeeze in capital values. This looks in fact to be what has happened and what will happen. Quite obviously with rental yields at these levels there is not much room for further growth in house prices, and a huge margin for a downshift.

Thus bricks-and-mortar is arguably the most risky global asset class in which to invest at the moment, unless you have a very special opportunity or intend to live in a house for a long-time on a mortgage and can ride out the peaks and troughs.