Subdivision in the ownership of buildings can amplify potential asset price bubbles in a city’s commercial real estate market, as well as being detrimental to the quality of urban life. Cities with a relatively high proportion of commercial buildings in multiple ownership, through strata title or deeds mutual covenant, are most at risk of mispricing the relationship between achievable rents and the capital values investors will pay.
Moreover, subdivision of buildings degrades public space, as it often leads to poor maintenance and considerable difficultly when redeveloping out-of- date building stock.
The combination of these two factors leads to the conclusion that city governments should ban further subdivision of single ownership in existing buildings, and severely curtail new multiple ownership developments in favour of single ownership commercial property.
The theories behind asset price bubbles are complex, with Alan Greenspan famously claiming it is impossible to spot them. However, professor Robert Shiller, author (with George Akerloff) of Animal Spirits and Irrational Exuberance, suggests there are some things we can look for to spot bubbles forming: high liquidity, high numbers of transactions and high rates of turnover of ownership.
In real estate markets, price bubbles can be created by lack of transparency, both from ‘money illusion’ – whereby the face (nominal) value of money is mistaken for its purchasing power (real value) – from inflation and investors trading ‘stories’ of beliefs that markets will go higher, along with a high rate of deal turnover and high liquidity.
The additional element for multiple ownership property is small lot size, which increases the number of investors who can participate in the market. In cities such as London, one cannot buy a floor of a building, as one can in Hong Kong or Singapore.
In Mumbai, floors can be subdivided with further multiple owners within a floor. The small lot size of a floor or even smaller unit allows higher levels of turnover and constant repricing in capital values, pushing yields fractionally lower on each deal.
Capital values per square foot are very often higher in multiple ownership buildings than in those owned by a single landlord. Often there is a lack of transparency about the rent likely to be achieved, which may benefit tenants, in that the multiple landlords may undercut each other to attract occupants, keeping rents down.
Blowing up the bubble
The combination of potentially higher capital values from repeat transactions, lower rents from under cutting, plus the higher number of participants through the ability to buy small lot sizes, amplifies the usual mechanism at play in commercial real estate investment, making investors more likely to enter bubble territory.
Multiple ownership broadly comes in two forms: statutory and common law contract. Hong Kong has deeds of mutual covenant on common law, while Singapore has strata titles on a statutory basis.
The difference may sound dull, but there is a distinction in that property rights held on a statutory basis are usually more clearly defined than those that are a private contract between parties. A look at the quality of the building maintenance in the two cities gives several clues as to the effectiveness of the two systems.
Multiple ownership property creates costs that are unfairly borne both by neighbours and wider society. The division of buildings necessitates more complicated management and maintenance.
The latter is often neglected due to the difficulty of getting multiple owners to agree on expenditure. Building management ordinances and strata management regulations only go so far; it only takes a couple of owners to refuse to pay, hoping for a free ride on the other owners, to have the system break down relatively quickly.
The additional costs of negotiation and enforcement for building management and maintenance weighs on society in the form of a poor environment, as buildings decay.
The solution is for governments to encourage smaller investors into commercial property through real estate investment trusts, or through shares in a single entity that owns the building. The REIT system gives investors access to income streams from commercial property in a more transparent way, with the building maintenance and management under the control of a single owner.
Ownership of buildings by a single entity is also essential to developing an institutional real estate market in Asia. We need a deeper stock of single ownership buildings so that growing Asian pension funds and insurance companies can access the type of stock they require.
In our modern, dense Asian global cities, multiple ownership of physical buildings imposes costs on the wider society. It is an archaic relic whose time has passed.
This article is first appeared in Asia Property February 2013.
About the author
Dr Megan Walters is the Head of Research, Jones Lang LaSalle Asia Pacific Capital Markets.