Professor Andrew Baum is one of the UK’s leading property academics, currently Visiting Professor of Management Practice at Oxford University’s Said Business School, responsible for developing the school’s real estate and real assets initiative. He is also chairman of Property Funds Research, a real estate consulting and research business, and Newcore Capital Management.

Jonathan Davis is an author, columnist and professional investor, editor of The Investment Reader and a regular contributor over many years to The Spectator, Financial Times and other publications.
www.independent-investor.com

It only takes a few minutes in the company of Andrew Baum, recently appointed as the first real estate professor at Oxford University’s Said Business School, to realise why he now prefers to be an academic rather than the successful full-time property professional he trained to be. His heart is in teaching and research and in having a platform to “speak truth to power”, however unpalatable that truth may be to the natural conservatism and vested interests of the property world or the head-in-the-sand attitudes of truth-averse politicans.

Before venturing into such topical issues as the shortage of housing in the UK (“scandalous”), or the merits of a development land tax (definitely “interesting”), I start by asking Prof Baum how he came to be involved in property in the first place. The “simple answer”, he says, is this: “My father was a chartered surveyor and I couldn’t think of anything better to do. I remember being interviewed for a law degree at LSE and King’s College, and feeling completely alienated by the conversations that were going on in the corridors by the students that were doing the degree. Their conversations seemed to me to be way too intellectual and well beyond my capacity to think.”

“My father was a chartered surveyor and I couldn’t think of anything better to do.”

“So I was put off law in my interviews and I ended up, through the clearing scheme at the ripe old age of sixteen, going to Reading University to do what was called Estate Management. Why I was in such a hurry, God only knows. The school I went to put me through O Levels in four years, rather than five, and it seems like I’ve been on an accelerated timetable ever since. I never walk, I always run, and life just seems to be short of hours.”

It took several years for him to realise that teaching and research, the life of the property academic he now enjoys, was for him. “My dad had given me some work experience in Leicester City Council’s property department, and I graduated at nineteen and got a job working for the district valuer at the Inland Revenue’s property department, valuing farms for estate duty.  Then I got a job at Reading Borough Council, in order to get back close to the university, because I think I’d realised by that time that being a teacher was probably something which was more appealing to me than being a committed, full-time property professional. So, I went back to the university and I taught at Reading for ten years, always doing something on the side – rent reviews, valuations, structural surveys of houses, whatever I could find, but enjoying teaching immensely. in the end, I felt that I’d accidentally stumbled across a career that combined the things I wanted to do with something that was slightly more remunerative than being an English teacher”.

So you have had a good deal of practical experience, at least, I say? “Well, a little. I did a lot of structural surveys of houses and most of them were probably professionally negligent because I didn’t really know enough about them! I can’t imagine I was very good at it. But you learn by doing. So, I was learning my trade by doing real work, while I was teaching and enjoying being in the classroom.” For the past thirty years, in aggregate, he reckons he has worked more hours in the professional world than in academia. What he calls his “reasonably serious” professional career includes founding two successful property research firms, acting as CIO of Henderson’s property business in the 1990s and launching one of the first fund of funds in real estate, a venture that subsequently became CBRE Global Investment Partners.

Property in academia

That raises the question, I say, of whether – and if so how – property is an academic discipline which can be taught. “Yes, it absolutely can be taught,” Baum says, “because property is a multi-disciplinary subject. To be a really good property advisor, let’s say, you need to understand finance, economics, law. It’s pretty easy to put together a syllabus that is reasonably intellectually demanding. You wouldn’t say it’s a property degree, but it would involve all of the things that you need to be comfortable with.”

“A property advisor needs to understand the law of contract, the law of property, financial models and how you use them to value pieces of property [Prof Baum is the author of several textbooks on the issue of property valuation]. You need to understand land economics and why some parts of the city are more valuable than other parts of the city. And then they will tell you that you need to understand construction as well, but I never really understood that. I think economics and finance are the basic building blocks that you can teach in property. But then you need to add those things together with practical experience to become a really valuable advisor, that’s for sure.”

But that is not the way it has always been taught, I say, reflecting on my time at Cambridge University when Land Economy was the favourite degree subject of beer-loving rugger players and would be members of the Blues boat, not always known for their academic prowess. That is probably true, says Baum: “I’m sure forty years ago, they’d have said that rowing was probably better taught than finance in Cambridge.”

But the Cambridge degree, he notes, has always been more about economics and the environment, so “the market has moved forward to meet them, in many ways, because sustainability and energy use are all concepts of environmental value and are relevant. That particularly chimes with undergraduates who want to feel that they’re doing the right thing, as well as just training to be somebody who’s going to make some money.”

What then are his plans for the newly created real estate programme at the Said Business School in Oxford which he now heads? Having been a part-time professor at Reading University for more than 20 years, and having spent five years teaching a finance course to Land Economy students at Cambridge, he says the objective is to combine teaching and directing a real estate MBA elective with research into important issues of national or strategic importance.

The first fruits of this effort was a pioneering collaborative study into ‘proptech’, an investigation into the ways in which new technology has the potential to change the way that property is owned, managed and used – a subject which as Prof Baum notes in his introduction, offers great opportunities to entrepreneurs in an industry “plagued by inefficient processes and uncecessary transactional costs defended by self-interested professionals and institutions”. The real estate business, he adds, “is not known as an industry which embraces change”.

Universities are a force for good in the world

Apart from teaching and research, his new job also involves “trying to build something from nothing, which fundamentally involves trying to raise money, in order to be able to hire people to work with me and to take it over from me in the coming years. I accept the responsibility that it’s something I have to do. It’s something I did at Reading University as well and it’s something that I believe has to be done. It’s a lot easier in the US because people’s propensity to give is much, much greater in the US than it is in the UK”.

“But we need private funding for world-class institutions. I’m proud of our university system. I’m proud of the fact that we’ve got five of the top twenty universities in the world. I think it’s a remarkable statistic, despite everything that successive governments have done to damage our position by restricting flows of immigrants into our university courses and not giving them any right of remaining, for example.”

“We have to do everything we possibly can to support our university system. Because it’s one of the few things that I believe is still a force for good in the round. Universities generally haven’t been vilified in the way that the police, MPs, the Church, journalists even, pretty much everything else has been brought down by scandal. It’s not really happened in the universities yet. I very much hope it never will.”

Does that then make him a supporter of tuition fees, I ask? “No, I’m no fan of tuition fees. I would much rather be in Harvard’s situation, where they don’t need to charge any tuition fees because their endowment is so big that they can afford to give university education away as a free gift to those who’ve most earned it. We’re in the opposite situation. We’re under much too much pressure to make money.” He name-checks an Australian university which runs a Master of Commerce course with 20,000 students paying large fees. “That is just a money-making venture which you wonder what the educational benefit of it is, other than to make money for the university. I’m sceptical about that.”

“I think Oxford University should be a break-even institution whose target should be to produce world-class research to improve the nature of the living experience. That’s what we should be about. And if the business school has to make a surplus to supplement science research, then fine. I accept that challenge. But there’s a limit. There has to be a limit.”

What conclusions does he draw from the polarisation of the property world around the issue of technology, the subject of his recent report?  “Those two sides just need to be slightly more familiar with the motivations of the other side. The stodgy chartered surveyor needs to understand what’s driving these 25 year olds into spending all of their waking hours developing tech solutions, and understand the way young people think about how they communicate with each other and why should they like.”

“But equally, the young entrepreneurs need to spend a bit more time thinking about why the conservative property professionals have done reasonably well in their lives, and what is it that a conservative approach to life has offered. They do need to understand that because you can waste a lot of money evangelising about things that ought to happen, but which the past has shown you never can. There’s mutual education needed.”

The housing shortage: what can be done?

The second research project Prof Baum is leading at his new academic home is on the shortage of housing, a political hot potato. “The two problems that we want to address are the absolute shortage of housing – and in particular the shortage of affordable housing – and then the growing issue of senior housing. How do we house older people? We don’t really have a market solution to that yet. I remember somebody telling me that the guy who started McCarthy & Stone [housebuilding firm specialising in retirement projects] was complaining that he was much too dominant, that he was a near-monopolist in the market. There’s just no other people doing what he was doing.”

“That seems crazy. I think we generally need to understand how we would best cater for older people in residential, how well the market is catering to them at the moment, and if it isn’t catering to them really well, what needs to change. And then the same thing about general housing supply, but in particular, affordable housing. I think that takes you back to the planning system. Is it correct to have an absolute ban on building in the green belt? Is there really a shortage of land for housing development? Do what extent do housebuilders stockpile land and ration it, in order to make more money out of land? To what extent should we use compulsory purchase powers to use fringe land for housing? I think there are a huge number of issues that need to be considered.”

“House prices are too high in this country and we just need to build more houses, not help people buy them.”

But is this not, I suggest, already a well worked area of inquiry? “I’m aware that there are lots of people working in doing research on housing, but I’m hoping that we can bring an angle to bear on it that is slightly different, through combining an understanding of property fund management, finance and the planning system, to push back against government’s constant small changes to the way housing is produced, and to stop their focus on the demand side, to stop giving people money to buy houses. House prices are too high in this country and we just need to build more houses, not help people buy them.”

The politics of pricing

Would he also include ultra-low interest rates as one of the factors in the problem, I ask? “Yes, definitely. I would include that and I would include the Conservative Party’s policy that was expressed most cogently by George Osborne in the lead-up to Brexit, when he said that if we leave the European Union, house prices will fall by 18%. The fact that he thought that was a point worth making is indicative of the Conservative Party’s attitude. There are plenty of people outside London who would be delighted if house prices fell by 18%. The fact that he didn’t understand that is just indicative of the Conservative Party’s pro-house acquisition approach to unbridled capitalism.”

Yet when Mrs May came up with her social care proposals in the Conservative manifesto, I say, she was shot down pretty quickly by both Labour and her own backbench MPs, for fear that it would threaten people’s housing wealth. “It was unfortunate because there may have been the bones of a good idea in there somewhere. We have to be able to cater for old people and for caring somehow, and clearly we need to be able to help people who can’t afford to pay for it, while allowing people who can afford to pay for it to enjoy the benefits of their savings and their hard enterprise.”

“There’s got to be some sort of compromise in the middle and I think she was trying to get towards that compromise. But she seems to be the victim of this country’s inability to face up to hard facts. People just don’t want to hear things that are difficult, that are less than idealistic. We’re going to go through another five years of muddling through, where the government can’t face up to making difficult decisions because it’s just electorally unpopular. And it’s a great shame, the situation that we’re in politically, because it means that we can’t take firm action.”

Is Professor Baum in favour then, going to the other political extreme, of a land tax? “Well, we do have a land tax already. It’s called the Section 106 and Community Infrastructure Levy. We do have these taxes where under the new London ruling, 35% of new homes have to be affordable. That’s effectively a tax. It’s just that we’ve evolved a system of taxing land appreciation in a backdoor way, and every time we’ve tried to tax it through a front door route, like the Community Land Tax and Development Land Tax, it’s smacked of overt socialism. And as soon as you lose a Labour government, then you end up with a reversal of that strategy. But we have evolved a land tax through the back door. So, we do have a reasonably socially democratic system.”

“But it’s a bit of a bugger’s muddle, to use a technical term, and it’s not working very well. One of the reasons it’s not working is because, as some of my colleagues at Reading University are researching at the moment, the developers can always complain that they can’t make the deal work with land prices being as high as they are. They can’t actually produce any housing if they are required to produce 35% of it as affordable housing, in which case, you see the planning authority might relent on the requirement for affordable housing, in order to get any houses built at all.”

“We should be able to control land prices more efficiently.”

“The issue that’s being created is to do with the price of land. The developer has happily paid too much for the land because he knows he can get away with reducing the affordable housing component. This is a scandal that is not well-known and is about to be broadcast, I think. It’s slightly technical, but it is indicative of the inability of government to face up to facts. The fact is we should be able to control land prices more efficiently, either through a use of compulsory powers – that’s what I would recommend, that we use compulsory acquisition powers to buy fringe land at less than full market value for housing (in other words, pay agricultural value plus a bit extra) – and bring that land into use.”

But compulsory powers exercised by whom? Which agent of government would that be? “Well, I’m not even sure we’ve got the right government department any more. I’m losing track. The Housing Department would presumably be the right place to do it, but the local authorities would have to instigate it. This is why we want to do our research, because we’re not completely sure that we understand the way in which the planning system is joining together with the financial system to produce land for housing. It’s trying to map that relationship which I think needs doing.”

Could we perhaps borrow some of the principles of behavioural economics to “nudge” people to create a system which encourages all of the various parties in property to work towards the wider objective of eliminating the housing shortage?  “Yes. I think you’re right. I think my example of land prices being too high is an example of behavioural economics. You know that by holding on to your land, if you hold out long enough, you’re going to get a good price for your land, when people keep telling you that there’s a shortage of it. But if you can crack that belief and persuade people that their land, if it’s not brought forward, it will be compulsory acquired at lower prices, then it starts to stimulate people’s minds more. Whereas with all attempts in the past to get brownfield land developed, it usually falls over because there’s no pressure on the landowner to bring the land forward.”

Build-to-rent has great potential

Passing over the issue of business rates (“I suspect it’s less broken than many things, but I’m not an expert”), I move on to ask how great is the opportunity for build-to-rent becoming a feature of the institutional investment landscape? “There is great potential,” Baum thinks. “Organisations like Legal & General are funding purpose-built private rented sector accommodation. I think they accept that they’re not getting the returns that they need to get to justify the risk they’re taking, [and they are doing it] simply because they need access to property as an asset class in the very long run. I think that’s quite a wise, grown-up approach – but it’s going to put off lots of other people.”

“There is lots of capital that wants to go into private rented sector development, but the economics are marginal at best. The housebuilders are often in a position where they can outbid private rented sector developers, but I think this is a sector that will grow in the UK, slowly to begin with, but steadily. We will have a significant rented sector, with purpose-built accommodation typically for the professional person in their twenties, who maybe doesn’t want to buy. They’ve been familiar with living in purpose-built student accommodation and they’d be perfectly happy going into something slightly better but similar for their first ten years of work. Developers like Greystar from the US are going to show us how to do it. Their financial models are going to be absolutely cut to the bone in order that they can compete head-on with the housebuilders, who tend to be able to pay slightly more for the land in most circumstances.”

“Alongside that, you get these tech platforms that are trying to change or introduce completely different models for people to access the housing ladder, with two different propositions – co-living, where you share living space, and co-ownership, where you put a small deposit down on a flat which is yours and you get co-investors to buy the rest, rather than go for a mortgage, on the basis that you can’t get a 90% mortgage but you can get 90% co-investments. So, there are some initiatives around like that.”

“I think the PRS is going to be the bigger winner in that market than the co-ownership proposition, which has been around for a long, long time and has never really gathered massive strength. I think there’s every reason why PRS should grow, because if you’re a pension fund and you can invest in an asset class that is fundamentally undersupplied with a demographic that means the demand is going to grow, and where the rents appear to have some sort of pegging to inflation, then you’ve got a beautiful asset.”

“Remember that index linked gilts are selling at -2% at the moment. So, if you can imagine creating a housing investment, where the rents are effectively index linked, where the occupancy is 95% year on year, then if the net yield is three percent net of all things, you’re getting 5% more than index linked gilts. That sounds pretty good. But most people say 3% is a horrendously low yield for a property investment, but it’s 5% more than index linked.”

The outlook for real estate valuation

This brings us to valuations – and what is the right way to value property in an environment of interest rates that have been deliberately kept low by government and central bank policymakers? As the author of three textbooks on real estate valuation, few people in the business are better qualified than Prof Baum to answer the question, but he confesses to being stumped for an answer.

“Right now, it’s a truly horrible, difficult situation for reasons I’ll try to explain. You’ve got to decide whether your property is offering you a fixed income or an index linked income. If you have property where the annual revenue tends to move upwards and there’s some theoretical link between the rent you get and the rate of inflation, which is, for example, student housing, then I would value that based on a projection of the income stream rising with inflation, net of all the costs of operating the building. I’d be discounting at an indexed gilt yields plus some sort of risk premium. That would make it pretty valuable.”

“If, on the other hand, you’ve got an office building like the one I’m sitting in at the moment, which my pension fund bought 20 years ago for £150,000, which is still worth £150,000, and where the rent that I’m getting is now slightly lower than the rent I first paid 15 years ago, that is not an index linked investment. That is a bond, effectively. The rent is pretty flat. And then the correct valuation basis is, let’s say, a ten year gilt yield, which is more like 1.5%, plus a risk premium. That’s a very different sort of investment.”

“The problem that we’ve got and the reason this is horrible is that both index linked gilt yields and ten year government gilt yields are artificially suppressed by monetary policy, as you said. Which means that right now, you can persuade yourself that property is very cheap because you’re getting these very high yields relative to the bond yields. A 5% premium over index linked, for example, sounds like a big number, because property investors are used to three or four with a risk premium. But you know that you’re being suckered into a trap where if index linked gilt yields go up, or if conventional gilt yields go up, you’re going to sell the building for less than you paid for it.”

“That is the fundamental problem affecting the UK right now. We are in a bit of a hole. Nick Leslau [the founder of Helical Bar] this week described the market as being constipated. People are not prepared to sell and people aren’t prepared to buy in great waves because they know that they’re being suckered into this trap. You can win because you might buy the property and bond yields stay low for a long time, or you could be hammered because you buy the property and bond yields stop moving up, because inflation’s already at 3% and the monetary policy group have gone to five to three in favour of keeping interest rates where they were. That is a bit of a shock, if we are much closer to raising interest rates than we expected.”

“So, we’re right on the edge. You’ve got two particular views of the market and the reason it’s so horrible to work out what to pay for property right now is because we just don’t know when bond yields will rise.” Is there not a plausible argument, however, I say, that governments and central banks are so aware of the debt problem they have inherited that the one certainty is that they will keep interest rates below inflation (“financial repression” goes on) for many years to come. Inflating debt away by stealth is the only way to eliminate the debt mountain.

“There has to be damage at some point. Somebody has to be damaged through this.”

Prof Baum acknowledges the point, but says: “I’m unprepared to come off the fence. I really don’t know. There has to be damage at some point. Somebody has to be damaged through this. The unwinding of this is going to hurt people, and it’s just a case of how fast that has to happen. I would imagine that most governments are going to be motivated to unwind the damage as slowly as possible, but my son is buying a house in London now. He’s got a baby and he needs a two-bed house. He’s got a one-bedroom flat. I don’t want him to buy because I think he’s being suckered into a trap. But on the other hand, what else does he do?”

On property cycles

Isn’t there however the property cycle to fall back on? Prof Baum has a surprising answer. “I don’t really believe in the concept of a property cycle. The academic work I’ve done on property cycles suggests that the only thing that really is cyclical is development. I need a theoretical explanation as well as empirical evidence to make me believe that something exists, and there is evidence of a development cycle because companies, when they get burned by building too much at the wrong time, tend to stay out of the market for too long, and then there’s a shortage of space which means booming rents. And then a lot of people come in and build again, and then there’s too many people building and then they get burned and then they go out of the market for too long. So, there is a cyclical nature of development.”

“But the capital markets have no cycle – and right now, property prices are dominated by the capital markets, not by the space market. It’s not the amount of building that’s going on. That’s not the thing that’s really making us worried about house prices. It’s the yields. It’s interest rates. It’s the fact that cap rates are so low. The capital markets aren’t in a cycle. There’s only one direction for cap rates to go, and it’s up. But we don’t know when. We might be at the bottom of a cycle that is going to take 20 years to unwind, we might be at the bottom of a cycle that’s going to take five years to unwind, or we might find interest rates actually go down again – just as after the Brexit vote, interest rates went down, unbelievably. So, sorry to be difficult, but the cycle exists in the development world and there’s a bit of overbuilding going on right now, given the likely demand. But cap rates and the capital markets are the bits that really are going to decide whether we get more and more wealthy, or damage ourselves. And they are very difficult to think about as a cycle.”

This uncertainty, he agrees, is holding back activity. “It’s definitely putting the lid on transactions, with the exception of the occasional very big deal with outside capital coming into the UK, encouraged by a low pound. We’ve seen a £1 billion transaction with Chinese money coming into London this year. That’s holding up the capital transactions data, but it’s very, very spotty, I think. It really is difficult for people to decide what to do at the moment”.

Open-ended vs closed-ended

We turn next to the question of property funds, where Prof Baum is happy to defend the role of open-ended funds against their critics. “Open-ended funds are superior in theory, is where I’d start. You’ve stimulated me into a response there. Closed-ended funds have no natural liquidity. Open-ended funds have some liquidity. The worst thing about open-ended funds is they become closed-ended funds on occasion. So, that’s why I think they’re better than closed-ended funds – although, granted, they do go wrong every now and again. But gating your investors is what happens to anybody in a closed-ended fund anyway.”

“Open-ended funds are better than closed-ended funds – although, granted, they do go wrong every now and again.”

“So, I’m generally a fan of open-ended funds. The fact is that they’re not going to produce massive returns at the moment. They are safe havens, or should be. The Brexit experience where the open-ended funds closed was quite a good one because they closed very quickly and opened again very quickly. I think that showed the market working reasonably well. The last time we had trouble with them was 2007 when they slowed down or became distorted for about a year, but then opened up again. They’re the closest thing we’ve got to a diversified low-risk exposure to the commercial property markets. So, I think we have to protect them.”

“The people who attack open-ended funds are usually people who work for investment banks or the public markets, where they’ve got a vested interest in selling or promoting REITs as an alternative. I understand the advantages of liquidity in REITs and it’s a great thing. But if you want a less volatile exposure to the property market, then open-ended funds are as good as you can get.  And of course, it was closed-ended funds that blew up in the global financial crisis, not the open-ended ones. They’re the ones that destroyed people’s capital.”

Proptech: a new frontier

Can new technology revolutionise the way that people invest in property? Fresh from the launch of his PropTech 3.0 report, which arges that the real estate sector, “being famous for its lack of capacity for deep and continuing innovation”, is ripe for change, Baum says there are different ways to look at the potential. “I had a meeting yesterday, for example, with a couple of guys who are property fund managers who set up a business that will raise money through a tech platform and offer investors the chance to buy units in commercial buildings, that they can then re-sell through the platform. So, that’s the obvious example of a new sort of property fund that uses internet technology to trade.”

“But I’m a bit sceptical about whether people will use those in great weight. Why would you invest £1000 in a single commercial building? Some people might, but I think I’d rather put my money into British Land shares. I don’t completely get it. I think the more thoughtful sorts of property funds would be investing in things that are going to be positively affected by changes that the technology world is bringing along. For example, most of our money goes into office buildings and retail property, but the formats that are most affected by technology are things like senior housing, medical properties, car parking subject to driverless cars, what we call social infrastructure. So, I’m a positive investor in social infrastructure, which is the sorts of property that we need, rather than the stuff which is generally over-supplying, which is retail and office.”

“Someone creating an efficient online trading platform for units in real estate will have to have a very, very strong brand name.”

“The use of technology to create retail distribution of property funds I think is slightly dangerous because of investor protection and the need to make sure that these things are appropriately governed and managed. Sooner or later, somebody might well be able to create an efficient online trading platform for units in real estate. But they’ll probably have to be somebody with a very, very strong brand name.” More generally, he thinks that new models of owning, managing and trading property are most likely to succeed when they tackle existing problems. Smart buildings are most obviously ripe for change, because “the demand is clear, the market huge, the technology increasingly available, and vested interests aligned”.