Our panel of experts discuss the best ways to catch the tide of global capital sweeping through Europe’s property markets, as fierce competition makes return targets harder to hit. David Hatcher reports. Photography by Marcus Rose
Capital continues to pile into European real estate, with €213.1bn of deals in 2014, according to Real Capital Analytics. It is coming from all quarters of the globe, with Americans, Chinese, Koreans, Malaysians, Australians, Brazilians and Canadians some of the cross-border buyers who figured in almost half of all last year’s acquisitions.
This has brought about strong price rises and pushed down yields. Finding good value is ever more difficult, but low yields in other markets and poor bond returns still make real estate a relatively attractive investment.
Our roundtable panel discussed the capital flowing around Europe’s real estate markets, working with investors, and the challenge of matching return expectations with the right assets. Around the table were Anthony Shayle, MD and head of global real estate, UK debt, UBS Global Asset Management; Jos Short, chairman, Internos Global Investors; Ross Blair, senior MD, Hines; and Mike Sales, managing director of Europe, TIAA-Henderson Real Estate.
Anthony Shayle: From a global perspective there are economies that are producing new, large pension pots of liability that have to be serviced. Some of those are largely based in Asia and there are some massive ones, for example, in China.
These will give rise to new international property investors. For example, two years ago many UK investors had limited if any familiarity with Ping An. They are trying to match their activity with what can generate a return appropriate to their capital sources.
Ross Blair: Many Asian investors set out to focus on only super-prime, core acquisitions initially, but are either forced, or by design, end up moving up the risk curve in search of return. Sometimes this is by design, as the market moves on.
Some of our investor partners are looking to invest for generations. Quality of assets and location, and stability of cashflow, are key and for large deals we have modelled over a 20 or 30-year time horizon. That type of investor is sat on a lot of capital and wants to get into the very best opportunities that will perform over the long-term.
Mike Sales: It’s interesting, though, that some Asian investors set out on that course but have traded and taken their money off the table. [Korean investors recently sold the HSBC tower in London’s Canary Wharf for a significant profit]. It’s perhaps a sign of passing off your credentials and showing you can play the cyclical market.
People talk about London being locked-up for the long-term and there never being a chance to buy certain buildings again, but I’m not sure I agree.
RB: One reason [for investors changing strategies] is that organisations can have a personnel rotation every three or five years and their strategy can completely change, sometimes due to individuals’ perceptions.
Jos Short: It’s ironic really as, if you’re an owner-manager like me, there is an enormous focus from investors on who the key man is in each area and your continuity.
AS: International capital goes into its own market first. So managers might consider understanding, and if possible supporting, local investors in home markets, then ally with them internationally.
MS: TH Real Estate is doing that in China, where we are building outlet malls. We are not only looking to bring money out of that market, but are investing there where we see long-term value and have the right local partner/operator and structure.
AS: The first time investors access a new market they are generally risk averse until there is confidence and more familiarity, when a willingness to take a bit more risk is seen, but it’s unusual for foreign investors to go straight into a private equity or value-
MS: The big, global investors we work with spend a long time researching and understanding foreign markets and the operators in those markets. When they go into a market they want to be absolutely certain that it is with the right partner – that’s their main decision.
Capital from Down Under
AS: Australian pension fund allocations have been increasing as the government has required individuals to put more money aside for retirement. As a result, real estate investment is increasing, off the back of a powerful, growing economy and a domestic market nearing saturation. They’ve gone to the nearest thing to their doorstep: Asia. It seems to take a long time for them to reach Europe.
JS: Also, Australian REITs took a bath in Europe in 2006/2007. A-REITs were trading at multiples of 20 times to earnings before interest, taxation, depreciation and amortisation at home and buying European businesses at 10 x EBITDA multiples, so they were immediately earnings accretive.
MS: The big guys are here, though, and have been for some time. There’s always talk of a wave of capital coming from Australia, but it doesn’t always happen, as returns there are actually pretty good.
We are slowly seeing the tier down from superannuation funds, which are big enough to go into joint ventures or have separate managed accounts. When the tier below that, of smaller pension funds, come, they will have to go into funds.
RB: Some smaller European and US state and corporate pension funds want to put $30m-$100m into funds as a first step to increasing their real estate allocation. They are probably more comfortable going into open-ended funds with relatively steady dividends.
JS: A wave of Latin American capital is also coming to Europe, which is a new trend. There is Brazilian capital – Safra buying the ‘Gherkin’ in London, for example – and behind them is a lot of Mexican, Chilean and Argentinian capital.
MS: Aside from the Brazilians’ need to diversify away from their home market, that is happening partly because their market is attracting so much interest from overseas that it is making domestic pricing less attractive for them than it used to be.
JS: German buyers are also still highly active, particularly in their own market. Debt is so cheap that you can borrow at an all-in cost of about 1% from German banks. They are still buying income – the City of London is a good bellwether for where they are: at 6% returns, it’s a good market for them; at 4%, where it is now, it’s not.
We have expanded and brought in new investors through mergers and acquisitions, including taking over Commerzbank’s fund management business, Commerz Real Spezialfonds. When we bought Halverton the investors were mainly multi managers who are now switching to co-investment deals rather than funds. Commerz Real included 40 German insurer and pension- fund clients, which we hope to be a rich stream of business, and they are all basically income investors.
MS: If you look at the bund market and negative interest rates, while real estate has got more expensive, it still delivers a very attractive income return, which is far more important to investors with liabilities than short-term capital growth. If you can put an annual 6% in their pocket for 10 years, and maintain entry price on exit (which can be challenging, depending on your long-term economic prognosis) they will be very happy.
JS: It also correlates to German valuation methodology; when a lease comes to within five-years of break or renewal, they value real estate like a bond and the capital value starts to depreciate quickly. A big new trend is US bond buyers that can’t deploy in the US deploying in Europe. What they don’t get is that real estate doesn’t always repay like a bond; it may have dilapidations and depreciation.
MS: A continuing trend is that many new and large European market entrants are not going into funds but are investing directly or using strategic joint ventures. They are sophisticated and are recruiting from local markets they operate in, and in some cases setting up local offices. Others are doing it through partnerships or remotely.
Equally, there is a risk for those who represent large, sovereign funds. You could invest and manage very well on their behalf for a few years, then watch them set up their own operation in a local market having acquired the knowledge and people to do so.
JS: These investors have supreme knowledge. If you go to see them you see another fund manager come out. You have to go in with an idea, and typically the model is manager-led. You can’t just ask them what they want to do, take their idea and do that.
AS: A lot of international investors don’t just want a return, they want a transfer of technology and knowledge, to build up their know-how. They do that either through being closely aligned through a joint venture or they have secondees in a joint venture and build up on-the-ground knowledge.
RB: When you look to attract capital you are often a function of your house style. Hines, for example, is known as an office specialist and we are a core and core-plus investor, so that’s what clients expect from you and it is why they come to you.
JS: It is changing, though, with managers buying new businesses to add on and others diversifying into new strategies.
AS: It is possible to be slick in moving from one strategy to another, but it’s also about having a good distribution arm and a strong track record on delivering what you say you are going to do.
RB: It’s important to be fleet of foot when investing to secure the right opportunities, and this is something we have been working on with our investors. Some now want to give us greater discretion; not full discretion, but for us to do deals more quickly when the market is hot. Speed and certainty of delivery are often as important as price, and that goes for both Asian and European investors.
For some accounts, in the past, we have made proposals to the investor and they have made final decisions, but they realise it makes sense to give more power back to the manager. They are partnering with a real estate specialist for a reason and they need to give more responsibility to the manager, who they are paying to make the decisions and who has a greater expertise in the local market and on executing deals.
MS: Despite the market being so hot, deals still seem to take much longer than they used to. That can be frustrating when you have a pooled fund or a vocal investor committee. Since the global financial crisis, there has been more emphasis on investors having a say in each decision, but that can be bad as well as good.
Maintaining a dialogue
AS: What investors want more than anything else is dialogue. It’s not just blind communication every three months with a 25-page document. You need to phone them to explain what happened this month, even if it’s just to say that things are going fine and that you’ll be in touch again soon.
RB: It is important to manage any conflicts with new investors, too, and this is taken very seriously internally. We have been fortunate on occasions where investors have said they want to achieve certain returns through a given strategy and we already have funds or mandates looking to achieve that.
You have to declare yourself out. We have very strict policies. Sometimes it is possible to club a deal if it is big enough, but often even if investors are looking for similar returns, they may be different in the way they operate and may not be looking over the same time periods.
MS: It’s nice to be big, with the economies of scale that can bring, but most importantly it brings access to more opportunities, which is vital in a fiercely competitive market. There is no discount for size in the current market – the bigger the better.
Euro funds missing US might
Why doesn’t Europe have a choice of large, open-ended real estate funds for international investors? This is a complete contrast to the US, where a multitude of such funds amass large portfolios that investors can enter and exit relatively easily. Because of their scale, they can buy large assets and provide steady returns to investors. However, replicating this the other side of the pond is anything but straightforward.
Anthony Shayle: For one of our core funds in the US, the federalisation concept appears to make the model work there, where big superannuation funds want to invest for long-term, stable returns. We have the EU, but it is a long way from the US federal model.
Mike Sales: We think there is a scalable opportunity in the European evergreen market for a long-term investment strategy with a strong, sustainable income return. It’s never, ever easy to start when we are nearing the top of a yield cycle, and with so much capital seeking high-quality assets — plus you have to start big to get scale like we see in the US with the Odyssey Funds, but there is a definite gap in the market.
Jos Short: European core returns don’t tend to be enough for US investors so you have to go to European investors and the cheques are €10m, €20m or €30m, compared to $200m or $300m in the US, so you have a problem with scale. It’s the holy grail to get a €5bn, pan-European, open-ended fund.
UK rented housing tricky to unlock
Investing in an institutionalised, private rented residential sector (PRS) appeals strongly to many fund managers, given the steady income it should generate. But creating such an asset class has proved tough in the UK, due to a lack of scale, land and development costs, and lack of government backing.
Jos Short: We have a PRS fund for the UK that we will market to local authority pension funds. They want to be in residential almost because it is semi-socially responsible investing, due to housing being too expensive and there not being enough affordable and social housing.
Mike Sales: PRS is something we are investigating. We need to create a product and run it in an efficient manner, like the US multi- family housing sector, which is very institutional. This is an emerging skill set in the UK and getting the right team and operator is essential to get first mover advantage.
Anthony Shayle: It is about critical mass. If you build a block of flats here it might have 100 flats. In the US that’s likely to be just part of a development of 500 units, where there are efficiencies with power, heat, light, communications, tenants moving in and moving out, and maintenance is a highly efficient, planned rolling process. The UK and most of Europe is comparatively fragmented.
Ross Blair: For us [when considering developing flats for sale] the challenge is securing sites to build scale. It’s tough piecing them together in city centres; there’s a lot more land available in the US to make it happen.
Outperforming in different plays
All four fund managers are targeting outperformance for their various investors, but each has a different strategy to achieve it.
Ross Blair: We will continue to be an office-dominated business, but the UK market is very intense and crowded, and we may sell assets in the next 12 to 18 months. That brings about pressure to find new investments and products, which is tough, given the competition. We are looking to buy more shopping centres, not just in the UK and Ireland, but also elsewhere in Europe, probably more than at any time in the past five years.
Jos Short: We are concentrating on the UK private rented sector, as well as residential in Holland and Germany, where we are also looking at care homes and hotels. The attraction of the Dutch market is driven by German investors who love German housing but are pretty full of it. Now the government is driving Dutch co-operatives to spin out their social housing, so the opportunity is there.
Mike Sales: Macro-economics and low interest rates will drive a lot of our investment strategies, which continue to focus on core/core-plus and income. These strategies include the designer outlet mall sector, logistics, UK dominant retail and central London offices.
Anthony Shayle: We remain encouraged by the UK debt lending market, despite scepticism from some that it was a flash in the pan. Ours is a high-yielding fund and we are encouraged to remain positive towards meeting our target returns, and have a strong pipeline.
Shayle runs UBS’s Participating Real Estate Mortgage Fund I, which raised £140m in a first closing in January and now totals £166m. It lends on high-yielding, complex UK deals and takes preferred equity positions. A final closing, which will bring the fund to around £300m, is expected in June. Shayle and UBS Global AM expect to raise a European fund of €500m-€600m in around a year’s time.
Short co-founded Internos in 2008, which now manages €3.9bn of assets. This includes 15 pooled funds totalling €2.5bn and 13 single-client or separate accounts totalling €1.4bn. The independently-owned business has eight European offices and expertise in the hotel and healthcare sectors, among others. It has grown via acquisitions, taking on run-off mandates and raising new funds.
Blair is responsible for all UK investment activities for Hines’ funds and third-party capital sources. The $24bn US property firm specialises in offices and development, but aims to expand its shopping mall portfolio, which includes Liffey Valley in Dublin and The Centre in Livingstone. Its office assets include Cannon Place in the City and Manchester development Landmark.
As managing director, Europe, Sales oversees the running and investment of TIAA-Henderson Real Estate’s European business, having been at the company for 20 years. The company manages around £13bn of assets across the continent. THRE was formed out of a merger between TIAA-CREF and Henderson Global Investors in April last year.