The principle that every person deserves their ‘day in court’ underpins justice in developed liberal market economies worldwide and is an essential component of a transparent legal and regulatory system generally. Since transparency is a key attribute for investability, it goes without saying that a loss of transparency damages the attractiveness of a market or an asset class. That includes real estate.
As a source of trust, transparency contributes to a business-friendly environment. It is indispensable for cross-border investors, particularly in real estate.
Troublingly, it has been undermined across a number of jurisdictions in recent years. Moreover, events in 2020 have reinforced the market’s perception that legal and regulatory systems – the ‘law’ in the title – are eroding in a number of countries as they no longer function as impartially and efficiently as investors have come to expect.
Real estate is a long-term physical investment that requires ongoing management, so the most attractive markets will be those that are transparent and less open to corruption. A reliable, trustworthy legal and regulatory framework is imperative throughout the lifecycle stages of owning property from buying, through managing, to selling.
A loss of transparency and less robust legal systems and regulatory frameworks can affect investments across asset classes. However, for long-term holdings such as directly owned real estate, analysts worry that any sense that legal or regulatory conditions could be deteriorating is particularly troublesome.
In April, at the height of the first wave of the COVID-19 outbreak, alarm bells went off as a growing number of tenants in Europe and the US were either unable or unwilling to pay rent. They did so regardless of contractual obligations, with some of the biggest companies in the world refusing to pay at all, or only half of their contractual obligation.
While large-scale payment refusals have not yet materialised, there are pending court cases involving international retailers and property owners over rent non-payment. Some major tech firms have indicated that they will not pay the rent due in their existing contracts.
Elsewhere, the summer has seen, at times, a breakdown in law and order as protestors attacked buildings and law enforcement officers in a number of major cities across the globe.
The events provided a reminder of the importance of public order and safety in large urban areas for investors in real estate.
Calls for budget cuts in law and order enforcement in some markets could raise questions about the long-term sustainability of the crime control measures that have accompanied the modernisation of gateway cities across the world, such as New York and Seattle.
Finally, the independence of the judiciary from political influence is being challenged. Last month, for example, an Amsterdam court recommended that people should no longer be extradited to Poland for trial because the Polish legal system is no longer independent.
According to the latest Jones Lang LaSalle transparency index, which assesses the ease of buying and selling property and analyses the legal and regulatory conditions affecting real estate ownership, the least regulated and most liquid markets such as the US and the UK appear at the top of the most transparent markets.
JLL observed that the spread of transparency in commercial real estate markets is slowing, with 2020 showing the weakest improvement in the period after the 2008 financial crisis.
Figure 1: Real estate transparency rankings – Jones Lang LaSalle
Source: Jones Lang LaSalle, 2020
Other more universal measures of transparency apply more widely.
The Corruption Perceptions index has been published annually by Transparency International since 1995. It ranks countries by their perceived levels of public sector corruption, as determined by expert assessments and opinion surveys.
The most transparent markets differ from the JLL list, with Nordic and European markets dominating behind New Zealand. Interestingly, the US and the UK lag.
Figure 2: Corruption perception rankings – Transparency International
Source: Transparency International, 2019
Organisations such as Transparency International confirm that the developments we have highlighted in this article are not random, isolated events. Justice systems are coming under concerted political pressure from different directions and the COVID-19 outbreak has exacerbated the challenges facing legal and regulatory frameworks.
Thankfully, law and order, and legal systems are not collapsing around us as governments battle the pandemic. However, the justice systems that have left investors feeling encouraged to invest internationally in real estate are fragile. They can be easily undermined.
So far, there have been no major moves by direct property owners or indeed outflows in listed real estate markets as the current focus is on the pandemic and many desks are unmanned due to the summer holidays, but investors are highlighting it as a burgeoning concern. Any weakening in the transparency of legal and democratic systems is a growing concern for all investors, including real estate investors.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Written 7 August 2020
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