Tony Key, Professor of Real Estate Economics, Cass Business School e: tony.key@city.ac.uk

1. Regional Economies and Commercial Real Estate in the UK: exploring the linkagesERES Conference, Milan, June 2010 Tony Key, Professor of Real Estate Economics, Cass Business School e: tony.key@city.ac.uk Colin Lizieri, Grosvenor Professor of Real Estate Finance, The Department of Land Economy, University of Cambridge e: tony.key@city.ac.uk

2. The research • Preliminary to more detailed & refined analysis • the distribution of investment stock in relation to economic activity • long run allocations vs market performance & fundamentals • the drivers of short-run investment flows • Illuminating issues in • neo-classical vs uneven vs institutional vs cultural spatial theories • long run economic growth vs property performance • causation & rationality in investment allocations • At this stage • standard proxy indicators of market dynamics applied to long run • regional scale of analysis recognising aggregation problems • to utilise full set of indicators, test methods, show the big picture

3. Literature • A bit of a blind spot • theories of spatial development mostly lack investment property • property market analysis mostly on short run dynamics • Regional economic development & investment property • skewed distributions of investment stock (Key & Law, 2004) • taken as evidence of cultural bias (Henneberry & Roberts, 2008) • alternative institutional / expectations explanations (Ball, 2001) • … lacking a comprehensive view of sectors, processes • Property performance, investment flow, local economies • US MSA market performance & economics (Piazzi et al, 2008; Liang & McIntosh 1998): weak links from long run economics to returns • US MSA returns & investment flows (Fisher et al, 2009): no consistent forward / backward linkage from returns to flows

4. Data & methods • All the usual UK indicators • performance (IPD), portfolios & investment flow (IPD), demand (ONS), stock (VOA), development (DTI) indicators • limitations of demand / supply proxies, IPD partial coverage • 11 GB regions, annual data 1981-2009, three main sectors • Analysis: regional variation within sectors • Stylised facts on regional property performance • Long run shifts: portfolios, investment flow vs market performance, market demand-supply fundamentals • Short-run dynamics: response of investment flow to relative performance, demand & supply • Basic cross-section & time series correlation / regression • More rigorous methods – Grainger, VAR – to follow

5. Findings 1 – regional long run performance • Large variation: terminal value of £100 invested in 1980 from £623 to £2,730 • Consistent pecking order industrial-retail-office for sectors & within regions • Differentials in return primarily the product of unpriced variation in rental value growth • Regional returns reflect risk only across retail regions Source: IPD

6. Findings 1 – drivers of long run performance • Across regions negative relationship between • demand growth and rental value growth • demand growth and total return • long run supply accommodates variation in economic growth • yield pricing does not anticipate rental or economic performance • consistent with Liang & McIntosh (1998) • But supply response does not explain rental variation • supply response measured by beta of construction volumes wrt demand, total construction per unit demand, total construction per unit demand growth • Weak level of explanation in supply factors may be due to low number of cross-sectional observations, problems with proxies, wrong level of aggregation

7. Findings 1 – regional long run performance

8. Findings 2 – long run portfolio allocations • All analysis on weights, relative performance within sectors • Changes in weights: • dominant effect in all sectors fall in London weights • balancing gains southern offices, northern retail, general industrial • weight shifts mainly produced by allocations of capital spending • Explaining changes in weights & investment allocation • nothing to do with long run returns or rental value growth • linked to rates of demand growth only in office sector • positively link to “oversupply” retail & industrial, negative in offices • no consistent regional preference across sectors • southern “bias” against relative performance only in office • no over-arching regional picture or weight driver

9. Findings 2 –investment flow vs demand growth

10. Findings 3 – investment dynamics • Tracking year by year within sectors • shifts in region weights produced by investment allocation • relative property performance of the region • relative economic growth & changes in new supply • To identify • direction & persistence in application of investment policy • sensitivity of investment to market cycle, economic fundamentals • regional typology of investment behaviour • leads / lags of capital flow, values & returns • Results • variation in strength, persistence, sensitivity of money flows • no consistent patterns across sectors / regions • no immediately obvious classification of policy “types”

13. Discussion • Basic facts • long run property performance independent of market fundamentals • long run shifts in allocation dominated by falling London weight • investment flows: mix of fixed preference, cyclicals, nothing obvious • no over-arching north-south or other regional differentiation • weak explanation of direction & changes in investment policy • Reservations & further work • limited by regional scale, basic methodology, broad proxies • more powerful methods: leads/lags, Grainger Causality, VAR • urban level (losing some indicators, lumpy flows may add noise)

14. Implications • Why the low level of explanation • regional scale means small number of obs, aggregation problems in terms of spatial scale, consistency problems with proxy measures • analysis is ex-post with full information, decisions are ex-ante with uncertain information • investment policy may be set by unobserved variables (benchmark hugging, deal flow, exit risk capital raising) • Paradigms of spatial adjustment • lack of consistent patterns runs against over-arching explanations • if cultural why not all sectors; if positivist why South East offices; if cumulative causation why northern retails • next steps to generate testable hypotheses from competing paradigms, and run with varying levels of aggregation