Europe starts to eclipse the US as land of opportunities

The big opportunity funds are targeting Spain, Ireland and the UK this year, writes Lauren Parr

Fundraising for opportunistic real estate investing has recovered strongly over the past six to 12 months, with Europe now offering greater opportunities than the US, which has staged a rapid recovery and is largely where the capital is flowing from. Money is also pouring in from the likes of pension funds, sovereign wealth funds and family offices in the Middle East and Africa. Patron Capital Partners’ managing director Keith Breslauer says: “The US has got better quickly so the amount of opportunities there are fewer than they used to be. If you’ve raised a lot of capital with a European allocation you can come to Manchester to buy at a 7% or 8% yield, rather than at less than 5% in New York.” Patron was one of the few managers to raise discretionary capital for Europe early on, back in 2012.

Investors have been trusting their money either to smaller European specialists owned by managers with excellent track records – such as Patron, Orion Capital Managers or Tristan Capital Partners – or  to a handful of global funds raised by disciplined US managers specialising in distress. The latter are allocating the lion’s share to European purchases. “Firms that have been able to do the full round trip are set apart,” notes Monica O’Neill, Tristan’s head of client relations and marketing, referring to the elite cohort that raised capital, invested it and managed to sell the assets profitably through the last cycle. Research published last December by PEI showed that private equity fund managers raised almost $100bn in capital for property globally last year – the highest figure for five years. But the most interesting trend was that there were 40 fewer funds than in 2012, but vehicles were larger.

Some $32.5bn – a third of the total – was collected by just 10 opportunity funds: Lone Star and Starwood closed funds at €6.6bn and €4.2bn respectively, while Blackstone is well on the way to raising a €5bn Europe-only fund (see tables and stories below). Rob Wilkinson, chief investment officer at AEW Europe, says a lot more US capital will be raised this year for similar deployment, because “some investors may not have deployed the capital they wanted to and others are still forming strategies”. Zsolt Kohalmi, Starwood Capital’s head of European acquisitions, agrees: “There’s a lot of excess liquidity trying to find a home globally owing to quantitative easing.”

Stretching the definition of ‘core’

Feeding into this trend is a shift up the risk curve by investors across the spectrum, as what constitutes ‘core’ is stretched and the core/prime end of the market in places like London becomes fully priced. There is money to be made in the UK, where values began to rise for assets outside prime London in May last year, and early movers such as LondonMetric are reaping the rewards. The quoted UK company has just sold Unilever House in Leatherhead to Malay-sian investor Lembaga Tabung Haji, advised by Gatehouse Bank, after buying it just 18 months ago. The sale made a 16.1% ungeared total return and a 32.8% internal rate of return. DekaBank and Deutsche Postbank were the lenders. Now may be the optimum time to invest in Europe, compared with other global markets. Europa Capital founder Noel Manns says the US has had a “good run”, with prices having recovered quickly. “Some global investors may have said ‘let’s leave the US alone for now, we’ve got some money in the market there’.” The growth story in Asian markets isn’t going away, while the window for investing in Europe is “a matter of timing”.

Debt markets have improved along with the economy, so distressed assets are coming to the market as banks accelerate work-outs of legacy assets. “Now markets are starting to recover, there is a chance to do something that may not be available in two or three years’ time,” Manns says. There is a wide definition of opportunity funds and varied approaches in how they get opportunistic returns. Some look at how real estate can be repositioned, for example. “Over the past four or five years property assets have been starved of capital, so there is a backlog of work to be done,” says Marc Mogull, managing partner at Benson Elliot.

Others are looking at debt structures and assets that need recapitalising, or using the ability to buy with equity now and refinance later, followed by a relatively quick exit into an improving institutional market. “Most of those who took the risk first, from 2011, were buying debt,” says Borja Sierra, Savills’ continental Europe CEO. Despite a divergence of fund strategies, most opportunistic investors favour elusive off-market deals over costly and competitive public auctions. “Sellers have been selling more slowly in Europe than there is demand – that’s what’s leading to pricing pressure. Everyone’s looking for an off-market deal,” says Kohalmi.

Funds are investing strongly in offices, with the UK accounting for more than half of the €22.9m Q4 European volume DTZ recorded, thanks to Central London deals, though these are a mix of prime as well as more opportunistic acquisitions. Retail also made a big comeback on the previous quarter in Q4 2013, up 75% at €12.3bn, led by activity in the UK, Germany, France and Italy, where MSREF bought into the 15-strong Italian Auchan mall and retail park portfolio for €635m in October, and others have been buying A few sector plays are taking place, such as a move into logistics (a big area of change owing to e-commerce) and multi-family housing, with the supply of affordable rented housing improving across big European cities. In the latter sector, early opportunistic movers such as Blackstone, Lone Star, Benson Elliot and Peakside are already selling assets on to institutional investors.

Investors need to get in early

But for a lot of investors there is less sector or geographical focus than might be expected. “It’s about where opportunities can be found rather than one sector being better than another,” says Nigel Almond, DTZ’s head of strategy research. Mogull’s mantra is to get into markets early. “Once everyone’s got their ‘sniper scope’ fixed on a market it gets harder to find value plays,” he says. “Opportunity funds started in the safest markets – Germany, the UK and the Nordics – at a time when there was little debt available and varying levels of distress. As  these markets tightened, investors moved to the periphery in search of returns: Ireland, Spain and, at the end of last year, Italy. More capital is clearly looking for a home  in southern Europe today.” Kohalmi says: “The Irish economy was the first to turn the corner. Anyone that’s put money away in Ireland has and will continue to do well there.”

Some investors believe severe distress in The Netherlands makes it the next place to go. Opportunistic money is also targeting France, where Lone Star has just bought Coeur Défense in Paris, via the iconic office complex’s securitised debt, at  a big discount. Saudi-backed Chelsfield Partners also closed a jumbo Paris deal early this year. In Ireland “the challenge now is the weight of capital on every opportunity that comes out”, notes Kohalmi. But many opportunities are coming to the market, especially from NAMA, and yields are expected to compress. They are still 175bps above pre-crisis levels in Dublin, according to DTZ.

Capital for European value-added and opportunistic investing will continue to flow into funds this year, a reflection of recovery, the expectation of more distressed assets to be traded in the market, and because capital is being deployed faster. Starwood is understood to be planning to launch a 10th opportunity fund this year, having nearly fully invested the €4.2bn fund it closed only last April. Its latest vehicle will follow the model of its previous global funds, with discretion to target most sectors and jurisdictions. “It’s the opportunity that will change,” notes Kohalmi. “Markets are moving faster than I’ve ever seen them move before.”

Mega-funds are back in business across Europe

The $99.3bn raised in 2013 by private equity real estate funds was the highest amount since 2008, according to PEI data. The capital was allocated to 199 funds globally – 40 fewer than in 2012. But the 20% fall in number was made up by a jump in average fund size, led by a handful of US managers who raised very large sums: in fact, a third of the capital raised flowed into just 10 funds.

Lone Star, Blackstone, Starwood Capital and Brookfield Asset Management each attracted more than $3bn and all four like Europe as the destination for a significant amount of that cash. After a slow fundraising period in 2012 and early 2013, investors started to commit in numbers last year and they wanted to invest in Europe. “We saw an enormous swing of sentiment from big US investors towards Europe,” says Europa Capital founder Noel Manns, whose Rockefeller-owned firm has been raising capital for its fourth opportunity fund and has had some success in the US.

Sovereign wealth investors also favoured global allocator mega funds: they have hundreds of millions to invest but cannot typically constitute more than 20-30% of any one fund, so managers that emerged unscathed from the financial crisis are benefiting. These investors also want to limit the number of managers they invest with. Very little of the opportunistic capital for Europe seems to be for targeted strategies.

Roger Barris, managing partner of Peakside Capital, which is tightly focused on Germany and Poland, is fundraising for its second opportunity fund. Last month he told Real Estate Capital: “Europe is number one on everyone’s list for opportunistic investing. The challenge is, there’s plenty of interest, but a lot is focused on the large, global funds. We’re having to find entrepreneurial LPs willing to look beyond big brands for more targeted strategies.” He wonders whether the multibillion  funds will make mistakes along the way: “They can only deploy money by taking big, macro bets. The best form of control for investors is requiring your manager to come back often for more money.”

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Spain is latest hot Euro destination for players from across the pond

Spain tops the shopping list of opportunistic investors ranging from Apollo and Fortress to Bayside Capital, Kennedy Wilson and Elliot Advisors. “Spain is the story,” says Europa Capital founder Noel Manns. Marc Mogull, managing partner at Benson Elliot, adds: “It’s mostly the hedge funds, which have made a market call and believe when the tide is moving you buy everything. Scale is more important than selection because all ships float in a rising tide.”

The market has changed radically in the past 12 months, with “none of the main guys wanting to touch Spain until last July”, says Zsolt Kohalmi, Starwood Capital’s head of European acquisitions. Then, says Magali Marton, DTZ’s head of CEMEA research, “people were still talking about Eurozone exits – this has disappeared from people’s minds, which provided greater comfort, although the structural risks have not necessarily gone away”.

However, with evidence that the economy was bottoming out came a rapid turnaround in sentiment and a queue of buyers by Q3 last year. Spain’s bad bank Sareb has begun  selling a few real estate portfolios – mainly residential real estate owned assets and some commercial ones – non-performing loan portfolios and single names. One of the latest of these was Project Walls: a nominally valued €100m commercial loan portfolio bought by Deutsche Bank. Blackstone, meanwhile, is trying to buy the Dorian package of mainly 620 homes in Madrid and Barcelona for $58m.

Further deals are expected to come from  Spanish banks that have spent the past three years acquiring more capital to exceed their 9% core capital targets. The next round of stress tests is expected to show that the majority of the 10 surviving Spanish banks will not need significant extra capital and that the majority of the restructuring in the Spanish financial sector has been completed. “We now need to digest the toxic assets and enormous volumes we have; we will  see these real estate owned and non-performing loan portfolios coming to the market because the banks will be allowed to take the loss,” says one Spanish corporate finance expert.

Mogull notes: “Transactions [in Spain] will be supported by improved lending availability – particularly for portfolio trades. Portfolio lenders are demonstrating growing comfort with the Spanish market, which is helping to underpin pricing.” One international bank offered financing of 50-60% on a REO portfolio at the end of last year. Goldman Sachs has financed deals  in Spain for the past three years and in 2013 provided Orion with €173.4m of refinancing for its Puerto Venecia Shopping Centre and Retail Park in Zaragoza.

Deutsche Bank started lending a year ago, while Credit Suisse is said to be interested in financing Spanish commercial property. Banks’ margins on such deals are typically 400-600bps. A string of bank loan servicing business purchases by investors including Apollo, Varde and Kennedy Wilson, Cerberus, and TPG and Centerbridge last year showed an appetite to get in early. “If you came in first, you see better than anyone how pricing is moving,” says Savills’ continental Europe CEO Borja Sierra.

Mogull argues that Spain’s popularity “has little to do with its market fundamentals”. Starwood’s Kohalmi agrees: “The investment wave has got ahead of the fundamentals,” he says. “The key is to find deals where there is less competition, often due to their complexity.” US investors Baupost and GreenOak Real Estate planted their flag in Spain last month, paying €160m for seven Spanish shopping centres and one retail park, in partnership with Spanish company Grupo Lar.

The trio got the assets at a 29% discount to December 2013 book value; vendor Vastned says the assets need €15m-€20m spent on them, given their age, and the “fierce competition” from nearby centres where they are located in Alicante, Barcelona, Burgos, Malaga and Madrid. Sierra agrees that there is “a bit of investment frenzy in Spain and we have to see how things will turn out. Price rises are a result of competition to buy, not necessarily fundamentals. Having said that, rents have stabilised at the right levels and incentives, and last Christmas virtually every retailer did better than they thought they would. I would give it two years for recovery in retail, but if you wait two years to buy, you won’t have access to these opportunities.”

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