Recovery has led to price rises, but investors still see openings, writes David Hatcher
If there has been one market that has captured investors’ imaginations more than any other this year it has been Spain.
Simply labelling the country as distressed is clearly now an oversimplification, as prices have soared, institutional players are outbidding opportunistic buyers and lenders are fighting hand over fist to get a piece of the action.
With yields now dropping to 5% for prime retail assets, those that entered the market early have got great value for their investments and have already seen capital values improve markedly.
Most investors think there is further value to be found and that the Iberian revival is just starting, with Spain’s economy showing its first tangible signs of improvement.
“We had the confidence to go in when we did because Madrid is one of the great capital cities of Europe and we were buying the best shopping centre there,” says Aref Lahham, founding partner of Orion Capital Managers. “There is always a need for the best places for people to shop.”
Lahham is referring to Orion’s purchase, at the nadir of the market in 2009, of the prime, 70,000m2 Plenilunio shopping centre in Madrid, for €235m. At the time the price reflected a 7.5% yield and Orion is thought to have gained what was then highly affordable staple financing from vendor Santander.
Earlier this month Orion put the centre on the market for €400m, a price reflecting a 5% yield, which would be a new benchmark for the cycle in Spain.
The pricing is a matter of great debate among Madrid agents. Some argue that it could be sold for even more; there are a range of estimates, but yields are thought to have compressed by around 150 basis points in the past year for prime stock.
More opportunities to come
Despite rising prices, Lahham sees more opportunities in Spain and Orion continues to invest in the country. “Institutions are moving back into Spain in a big way, that is very clear in retail particularly, and we are getting unsolicited offers for our assets,” he says. “There’s more to come; the process is only just starting. Our job is not to try and be too clever and sell out at the very top.”
As a private equity investor with high return targets, Orion is looking to move up the risk curve. In October, with Cerberus Capital Management, Orion agreed to buy the Sotogrande resort near Gibraltar for €225m from NH Hotel Group. It includes 678,000m2 of residential and hotel development and 1,038 acres of land.
“We are looking at illiquid pockets,” adds Lahham. “There are always opportunities and we don’t think Spain will fall off a cliff.”
Europa Capital is another investor that bought heavily into Spain early in the cycle and harvested returns this year, but still sees value in the country. In 2009 and 2010, with RREEF and AREA, it bought and leased back more than 1,000 BBVA bank branches, plus office buildings.
This July it sold part of the portfolio to SOCIMI (the Spanish REIT structure) Merlin Properties for €739.5m.
“At the time, when European banks were under extreme pressure, we took a view on the BBVA covenant,” says Charles Graham, principal at the firm. “We looked hard at the underlying real estate and saw multiple possible exits, be it granular, in groups of assets or as a whole. They are on 30-year sale-and-leasebacks and provide the sort of return that insurers still eager to gain real estate exposure might need.”
With the market having moved so dramatically it would be impossible to pull off such a deal now, which has led Europa to make an early entry into development.
“We are trying to find opportunities in Spain where equity is still scarce and in the development market, there has been so little construction for so long that there are areas that offer opportunities,” says Noel Manns, Graham’s fellow principal.
“But it is increasingly difficult for us to find value. Some people are buying at prices that we would have priced as an exit.”
Europa plans to redevelop retailer Desigual’s outlet at Casp 33 in Barcelona into 15 luxury apartments. Work will start early next year, in a joint venture with Bonavista.
Institutional capital returns
Macroeconomic indicators have been a big factor in bringing institutional capital off the sidelines in 2014 after a number of years.
For example, in October TIAA Henderson Real Estate agreed to buy the 90,000m2 Izlazul shopping centre in Madrid from Ivanhoe Cambridge and Grupo Lar for €235m, reflecting a 5.5% yield. ING Real Estate Finance provided the debt.
In May the European Commission predicted that Spain’s economy would grow by 1.1% this year, with a 2% rise expected next year and 2.2% in 2016. Unemployment has also been forecast to drop to 23.5% next year, from a peak of 26.9% in the first quarter of 2013, and to 22.6% in 2016.
“Private equity firms have generally been looking to gain exposure early by doing big trades, but institutions have only recently had the comfort of seeing the first signs of true economic improvement, and can now move in with confidence,” says Susana Rodriguez Garcia, managing director of the consultancy division at Aguirre Newman.
There seems to be a consensus that these economic improvements are partly the result of positive action by the government a couple of years ago starting to take effect. This includes setting up “bad bank” Sareb in 2012 and relaxing the country’s labour laws.
“Three or four years ago private equity firms came over expecting to buy the best office building in Madrid at a 9% yield, and that wasn’t going to happen,” says Rodriguez Garcia. “Local buyers had not geared highly and didn’t need to sell. As a result, we had very low deal volumes for a long time.
“It took time for Sareb to be created and listed companies had to refinance. Once this was done, the market restarted, at the same time as broader improvements in the economy. As a result, the prices buyers were willing to pay and sellers were willing to sell at came closer together.”
A further game-changing move was the introduction of SOCIMIs. Grupo Lar was the first to launch, with a €400m listing in February. Hispania followed the next month with a €500m initial public offering, while Merlin Properties overshadowed them all by raising €1.5bn in June (see July/August issue, p21-28).
This has given extra impetus to the investment market. Selling to Spanish REITs gives a potential exit route for foreign investors that have already moved in, with those that are considering such a move now confident that there will be liquidity.
“The Spanish investment market has changed completely because of SOCIMIs – we now have a whole new set of buyers,” says Ignacio Iturriaga, partner at advisory firm Irea. “Before, Spanish companies were unable to compete with those from overseas, as they did not have the tax advantages.”
Big loan portfolio trades
While the likes of Orion and Europa have been looking to sell to institutional investors, there are other opportunistic buyers that have invested heavily in Spain this year through loan portfolio trades. The largest of these came in May, when Lone Star and JPMorgan bought Commerzbank’s €4.4bn Project Octopus portfolio.
Lone Star is understood to be starting refinancing talks with some borrowers, while JPMorgan is thought to be looking to carve up and syndicate its performing loans element of Project Octopus, to take advantage of the improving market, having already sold an €800m portion to AXA.
The Spanish market is rapidly evolving. Those that were brave enough to enter early now have the opportunity to realise profits – but also have a tricky decision on how to continue to make big returns.
Institutional players, meanwhile, need to decide whether they are still getting good value when pricing has already risen such a long way. Next year could be another one packed with dramatic activity.
Prime debt margins halve as lenders return
Improvements in the financing market have added fuel to Spain’s real estate fire. Margins for prime retail property have reduced from 400-500 basis points a year ago to 200-300bps now.
“The market has become a lot more competitive, with new entrants and more appetite from domestic lenders,” says Wouter Mijnen, general manager of Spain and Portugal for ING Commercial Banking. “As a result, margins have come in a lot and loan-
to-value ratios are rising.
“This is very positive for the Spanish real estate market, as it provides the increased liquidity that will lead to more transactions being closed,” Mijnen adds.
See November issue, pp12-13, for more on the recovery in Spain’s debt market