Sunny skies, cautious sentiments

The European property sector decamped to MIPIM last month. Although most were upbeat, caution was the watchword, reports Daniel Cunningham

The mood at MIPIM, which took place in Cannes last month, was perhaps lifted by the beautiful weather on the French Riviera. After wind and rain subdued the atmosphere at 2016’s conference, this year’s event was bathed in sunshine.

While many of the property people gathered along the resort’s Boulevard de la Croisette put forward a positive argument for the fundamentals of the sector, conversations revealed a growing awareness that the European real estate market is late-cycle and caution needs to be exercised.

On the fundamentals, a sentiment repeated by many was that the weight of capital focused on Europe’s property markets remains immense. However, data unveiled at the event by Cushman & Wakefield showed that global real estate capital – equity and debt – dipped slightly in 2016, for the first time since 2011. The firm’s Great Wall of Money report showed that by the end of last year, capital had decreased by 2 percent to $435 billion. But with interest rates still low, fixed income investors remain keen to benefit from the steady and competitive returns real estate generates.

Finding the right investment opportunities is the challenge, several delegates said. Many sectors across Europe look fully-priced and opportunities for value-add plays are difficult to source.

Finance directors from the major investment houses were keen to stress, though, that when they source deals, debt finance is available to fund them. Jirka Lhotak, EMEA CFO for CBRE Global Investors, said that lenders have not pulled back.

“We see strong lending appetite for core assets. Margins have come down and there is strong competition, but the market is not like 2007 when banks seemed to be operating at break-even,” he said.

George Aase, CFO of P3 Logistics Parks, which secured a €1.4 billion refinancing of its pan-European assets last October, said: “We have not seen any troubling signs in the provision of financing. When I speak to lenders, they indicate a strong appetite to lend. We’re even seeing greater availability of development finance. Banks are more willing to consider 30-35 percent pre-let schemes rather than 50 percent.”

Bankers and insurance lenders made known their healthy 2016 lending volumes, while reminding listeners that risk parameters were not compromised to achieve them.

On pricing, lenders expressed the view that lending margins have generally reached a floor within Europe. German pricing remains extremely low, with market watchers noting 80 basis points. Lending on prime Paris real estate was seen within the 120-130 bps area, while southern European pricing has compressed. Whereas this time last year Italian margins were above 200 bps, most agreed that core Milan and Rome assets would now command 150-200 bps.

ING Real Estate Finance’s head of Italy, Michele Monterosso said: “We see improving investor appetite in Italy in all property sectors, progressively even in southern retail where yields are reflecting at least 200 bps premium.”

As for the UK, the general sentiment was that last June’s EU referendum result forced pricing up by between 25 and 50 bps to circa 170 bps for prime deals. “We did a UK deal at 150 bps last year; that would be around 190 bps today,” noted one finance director. German insurer
Allianz Real Estate is actively building a UK loan book and announced at MIPIM that it has taken a participation in the
loan underwritten by Morgan Stanley against the CityPoint tower in the City of London.

Head of debt Roland Fuchs said that the UK remains attractive for a core lender: “Good deals find lenders in the UK. There’s a 10-15 percent currency effect, but our long-term view on London is positive. We like to invest where there’s a sustainable gateway city story.”

The message coming loud and clear from lenders was that they continue to deploy capital, within their risk parameters, based on the solid fundamentals of Europe’s property markets. But how long can this last? On the subject of where we are in the cycle, most agreed that the market is either almost at, or even slightly over the peak. However, few were prepared to estimate just how long is left.

“We have seen the top of the market,” one senior European banker said, “but no one knows how long this current stage of the cycle will last. From a lending perspective, most are cautious, but no one wants to lose market share, clients and income.”

The banker argued that, as long as sensible loan terms are agreed, it is still too early for banks to apply the brakes sharply when the investment market remains strong. “But if you ignore where we are in the cycle, that’s when there are problems,” he added.

Timothé Rauly, head of funds group at AXA Investment Managers – Real Assets, said: “In the next two to three years we need to monitor the market very carefully. It’s difficult to bet on yields going down any further. However, the income element of returns could go up, based on the fact that lots of the prime stock was rented in 2014 at super-low rents.”

CBRE Global Investors’ Lhotak agreed: “On yields, we are around the top of the cycle, with the US as the frontrunner, followed by the UK and then the rest of Europe is lagging slightly. There is very little potential for further yield compression. However, on the income side, there is definitely rental growth potential in selected offices and retail. We feel quite confident about 2017, but not complacent.”

A point many were keen to make is that the real estate lending market is in better shape than it was at this point in the last cycle, when MIPIM was more lavish and less business-like than today. Christian Schmid, managing director, business and syndication management at Aareal Bank said: “Looking at the markets in general, conditions are very different to the last time the markets reached their peak. Leverage is much lower, there is much more equity at play, and lending risk is more diversified across sectors. The underlying economies are in better shape than they were in 2006-7.”

Looking forward, lenders and borrowers admitted that the economic and political factors at play in Europe are on their minds. Everyone is focused on potential triggers for a decline in values, such as pressure on interest rates and European elections.

The results of the Dutch election, which emerged during the event, came as a relief to many who feared the increasing influence of populism in European politics.

“In the ranking of concerns, politics and protectionism is quite high on the list,” one banker said.

However, while politics and macro-economics came up in conversations, many concluded that it is almost impossible to predict the future. Perhaps a degree of uncertainty-fatigue has set in. “We have got accustomed to the uncertainty,” one German
banker admitted.

The European real estate market is largely past the growth stage of the cycle and those gathered at MIPIM generally acknowledged that the market’s future is difficult to forecast. While underlying property markets still seem robust most remain keen to do business. The unanswered question – and one which the market might still be asking at MIPIM 2018 – is how long can it last?