Special Report: Capital remains mobile

Global capital continues to flow into Europe, but while North American opportunistic money is gradually exiting, Asian institutions are in buy-mode. Lauren Parr reports.

Europe’s real estate market remains a magnet for global capital, although there is a notable shift in where that capital is coming from.

CBRE figures show that total investment in European commercial real estate stood at €255 billion in 2016, a drop from €278 billion in the previous year, but up on 2014’s €226 billion. Around half of 2016’s investment volumes came from domestic investors, relatively consistent with the previous year. The other major sources of money were North America, Asia-Pacific and the Middle East.

Europe-wide, North American money remains dominant, but volumes fell markedly between 2015 and 2016, from more than €40 billion to less than €25 billion. Asia-Pacific capital counts for less of the market – at around €15 billion – but in contrast to North American money, it remained fairly stable between the two years.

Focusing on the UK market, Asia-Pacific capital overtook North American money last year. Asian investors increased their market share of UK acquisitions to 13 percent, up from 4 percent back in 2010. North American investors’ share of the market, meanwhile, dropped from 18 percent in 2014 to 10 percent in 2016.

One driver for this is the point in the cycle. US investors typically fall into the private equity category; those that moved in early in the cycle with a willingness to “ride the wave and get out before the market seems to be heading towards a peak”, explains Jos Tromp, CBRE’s head of research for EMEA.

At this point in the cycle, US private equity firms are becoming more focused on sales, reflecting the realisation of business plans and following strong yield compression in Europe during the last couple of years.

With underlying property fundamentals more stabilised, the environment is ripe for those institutional Asian investors which are seeking core investments in proven markets.

Asian economies have been growing, meaning that even small percentage changes in institutions’ allocations to real estate equate to substantial sums. In addition, deregulation of insurance companies in some Asian countries continues. Increasingly, European markets are targeted by investors from China, Singapore, Japan, as well as South Korea and Malaysia.

“Asian investors have made their first investments in Europe and are building on that,” adds Raphael Rietema of CBRE’s global research and consulting team, based in the Netherlands. “They have been looking at trophy assets for quite some years now and have become increasingly successful in outbidding counterparties; they know how the process works now.”

Cash-only deals

The issue for lenders is that while US private equity firms had a strong appetite for debt, many Asian investors have the ability to do cash-only deals or bank with relationship lenders from their home markets. That is gradually changing however, with several major financing deals by European banks to Asian sponsors.

Despite the Asia trend, North American capital remains the largest external source of investment into European real estate. A particular focus for them is European retail. The sector took a big hit post-crisis as consumers spent less, while also undergoing structural changes relating to the online world, but it is now presenting opportunities again. Private equity buyers actively stepped into situations in the Dutch retail market last year, which reached a peak in terms of retailer bankruptcies.

Middle Eastern investment into European CRE dropped slightly between 2015 and 2016, but was fairly in line with 2014.

However, there was a notable shift in sentiment during the second half of 2016, thanks to the strong dollar and rising oil prices. According to Fidelity International, €1.9 billion was invested in the UK and core eurozone combined following a relatively quiet start to the year.

“Political developments in the US serve as the latest push factor for Middle Eastern capital to flow into Europe,” says Iryna Pylypchuk, senior research analyst at Fidelity. She expects the total UK and core eurozone spend in 2017 to bounce back to circa €5 billion, in line with the 2014-16 annual average.

Middle Eastern sovereign wealth funds are very active in gateway markets while family offices and private individuals started buying in core western European markets like Germany and the Netherlands last year. They were responsible for 15 percent of non-European cross-border investments into Europe, according to CBRE.

On a global relative value basis, European real estate is still reasonably priced, Tromp says. “The spread between interest rates and property yields has never been as big.”

Tromp adds that a substantial rise in interest rates would need to occur before prime property yields are impacted. “If you move up the risk curve and look at secondary assets the gap is even bigger so there is still some time to go before property yields in Europe are expected to materially change.”

Steve Williamson, CBRE’s head of UK & EMEA debt and structured finance agrees: “There are good investment opportunities in Europe for global investors, and for well-regarded sponsors with strong assets seeking debt, there is good liquidity at attractive rates in most markets.”

Improving Europe

Tromp remarks that global investors have concentrated their activity on continental Europe, due to the uncertainty in the UK market. In addition, with potential growth expected in the US economy, at least some of the private equity funds that had been allocated to Europe will likely be redirected to the US.

Despite the increased political uncertainty, economic prospects across Europe are improving, says Tromp: “We are now seeing growth spreading out from the bigger European economies to even the peripheries. Spain’s labour market is growing again while Holland is now one of the fastest growers.”

There is still a lot of cross-border capital moving into real estate from within Europe. In addition, investment by domestic buyers still accounts for around half of yearly volumes, CBRE’s data shows.

“We’re going to see a more even split between local and cross-border money,” says Tromp. “In many markets the importance of local players will increase again, driven by the fact that local investors had issues around the crisis in their respective countries but that capital has now recovered.”

As the hunt for yield continues, institutional money is taking centre stage. That suits some non-European investors, but as US private equity gradually retrenches, European cross-border institutional capital will also play a major role in taking its place.

All this means that the strength of equity in the market is formidable, making investments more sustainable. “There is a far lower presence of banks in deals these days,” notes Tromp. Back in 2007 leverage of 70-80 percent was applied compared to 40-50 percent today.

“Lending is always needed but this cycle is truly different to the last as
there is so much equity around,” Tromp adds.

“Institutions are becoming a more important factor in all of this, in relative terms causing less demand on banks.”