Capital flows: Investors keep calm and carry on through eurozone crisis

With the Euro crisis spooking investors,  the volume of European deals has slowed markedly in the past few months. However, unlike the meltdown of 2008-09, the commercial real estate market has not frozen yet; at €129.5bn, deal volumes last year were 8% up on 2010.

“Investors don’t like uncertainty and there’s no doubt that is holding back some of them,” says Robert Gilchrist, CEO of Rockspring. “Equally, some investors see this as an opportunity.” Debt is scarce, but there are mountains of equity waiting to be deployed – although investors remain cautious and choosy.

“This time, cross-border capital is being maintained, which is a very positive trend,” says Joe Kelly, a director of market analysis  at Real Capital Analytics. Last year, €52bn of cross-border money flowed in, 40% of the total. North American capital was particularly evident in 2011, especially from Canadian pension funds. Between them, OMERS and Oxford Properties spent £806m in the UK, while CPPIB snapped up a German shopping centre and teamed up to buy ING’s industrial fund. US opportunity funds led by Blackstone also purchased some large portfolios.

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US institutions wait on the sidelines

Busy at home, US institutional investors have been cooler on Europe. “Half of them are scared and worried and want to wait,” says Laurent Luccioni, MGPA’s European CEO. “The other half think the opposite; that Europe now is like the US in 2009, and they recognise that they missed an opportunity then.”

However, US opportunity funds, scenting that a new cycle is starting for them, are raising huge amounts of capital. Blackstone, which spent €1.24bn on a hotel portfolio and a London business park, has already attracted $6bn to its new real estate fund and expects to close it with $10bn next year “A lot of US investors are trying to access distressed property in the US and not being successful,” says Kelly. “Now they are seeing more opportunities in Europe, both on the debt side and asset side.”

Paul Vosper, head of RREEF’s client relations in Europe, says a low-growth environment, with more transparency on bank balance sheets, is putting huge pressure on banks. “Towards the end of the year we’ll see more extensive transactions reflecting true distress,” he predicts.

“We are going to see very interesting opportunities in Spain and Ireland over the next six to nine months. They are not for the faint of heart; you’re taking on less asset risk and more macro risk. But as the macro picture resolves itself, those markets will start to look attractive.”

Stock pickers hunt for value

Opportunity funds aside, investors are hunting value across Europe. “It’s definitely a stock picker’s market at the moment. Investors are quite nervous, looking for security and higher-quality assets, rather than having to make the call as to whether Germany is better than France or better than Sweden,” says Gilchrist.

Hence there has been a rush to defensive, income-producing assets. Last year, 40 fortress shopping centres changed hands in Europe for a total of €8bn, two-thirds of them bought by cross-border investors. The UK’s capital topped the international league, with €20.6bn gushing into London, second globally to New York.

Asian investors are particularly prominent in London. The attractions for them are obvious: it is a big, transparent and liquid market in a politically stable country, and offers a more foreigner-friendly investing environment than many of its neighbours.

In London, the weight of overseas capital pressing down on the core London market is pricing out the local European institutions.



However, INREV’s annual survey on the future investment preferences of unlisted funds found that the UK has dropped down the ranking, with German retail now the favoured country/sector combination for nearly two-thirds of those polled. The Nordic region also figured prominently. Global investors are also looking to Germany and France.

“In 2012, pricing will be a key factor as well as how the eurozone crisis plays out,” says David Green-Morgan, head of Jones Lang LaSalle’s capital markets research. With core and core-plus property looking pricy, a substantial amount of capital in Europe has moved up the risk spectrum this year.

According to Emerging Trends 2012, PricewaterhouseCoopers’ and the Urban Land Institute’s canvassing of Europe’s real estate community, 53% of respondents’ allocations would be in riskier value-added, opportunistic investments, debt, or development.

Development dries up

“I’m intrigued by the quite significant lack of new construction in many parts of Europe, largely due to lack of debt finance for new development,” says Gilchrist. “That makes me a bit more positive about the prospects for rents. We haven’t really had a rental cycle of any true nature for some time now.”

Luccioni adds: “A lot of secondary assets need prices to fall to make them work and debt is not going to come to plug that gap.”

Some think a 5-30% price drop is needed, but it is not clear how fast and how far vendors, especially banks, will be prepared to clear out their less-than-prime stock.

“Economies are muddling through, but these are times when you can buy assets of interesting value at interesting prices,” concludes Luccioni. “You need to have a plan of how to develop that value and how to exit the asset. But at least you can buy things that are attractive in terms of entry price.”

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Warsaw is at the heart of Central European revival

Central Europe is the unexpected hotspot for investors, with investment there spiking to €7bn last year, 5% of Europe’s total.

“Demand is improving and quite strong office rental growth is forecast,” says Joe Kelly of Real Capital Analytics. “Most of the investment has come from cross-border players: German investors, US opportunity funds and retail funds.”

Last year, almost half the capital invested in the region went to Poland, the only EU country to avoid recession. Most of it went to Warsaw, ranked the city with Europe’s third-best investment prospects in the Emerging Trends report from PricewaterhouseCoopers and the Urban Land Institute, despite decelerating office rent expectations.

The retail sector is also strong in the region, attracting international brands, and there is undersupply of shopping space. Last year, €2.7bn of retail changed hands, with Blackstone, Atrium and ECE buying new shopping centres. “Investors bought not just core, but suburban malls,” notes Kelly.