At PERE’s European roundtable, a discussion of Europe held in the UK inevitably turns to debate over the UK in Europe. Brexit dominates political and economic discourse in Britain ahead of the putative March 29 deadline for the country to leave the EU. So when the five participants meet in London in February it is predictably high on the agenda.
Brexit is far from the only concern for institutional investors in European real estate, however. Prices are high, the cycle is generally increasingly febrile.
That is the context for a lively exchange about how to find value in a competitive and unsettled market between the four investment managers present: Michael Neal, chief investment officer for Europe and Asia-Pacific at Nuveen Real Estate; Mark McLaughlin, managing director for Europe at Cromwell Property Group; Rob Rackind, partner and head of EQT’s real estate advisory team; and David Skinner, managing director for strategy and fund management at Aviva Investors; and one lawyer: Peter Sugden, managing partner of Katten Muchin Rosenman UK.
With the UK struggling to make any headway in its negotiations with the EU and the prospect of a disorderly Brexit growing by the day, several of the participants are putting their UK acquisitions on ice, at least in the immediate future. “Our conclusion is: there is no need to speculate at present. EQT will only invest in the UK when there is certainty over whether it will be a soft or hard Brexit,” says Rackind.
McLaughlin adds: “We are not saying no to the UK. We want to grow here, but in this uncertain period over the coming weeks one needs to be careful.”
Sugden says his investor clients too, are holding back to see what effect Brexit will have before committing themselves to UK activity: “Investors are waiting for the opportunities created by Brexit-related dislocation, or waiting for stabilization so that they switch their attention away from mainland Europe and start investing to the UK.”
Meanwhile, his firm’s clients face uncertainty over their post-Brexit operations: “For our financial services clients, it is passporting arrangements to continue doing business in the EU that is the greater concern.”
Neal, of Nuveen Real Estate, which recently rebranded from TH Real Estate, takes some comfort from the UK capital’s continued popularity with investors. “It has been known that we are heading toward this exit date at the end of March, yet London was the most liquid market globally last year with £16 billion ($20.6 billion; €18.3 billion) of transactions and it is a supply constrained market with high take up,” he argues.
Skinner says Aviva Investors saw some redemptions from its retail funds last year, “but the volume was not as high as after the referendum in the summer of 2016 and redemptions have abated since.” Moreover, he reflects that the UK tenant market has remained robust:
“Actually, since the referendum, corporate occupational decisions to take on lease liabilities have held up pretty well, and continue to do so at least in the markets on which we are focused.”
Flatter for longer
In continental Europe, the principal challenges to investors relate to the economic and property cycles. The European Central Bank brought its program of quantitative easing to a close in December and many observers anticipate that interest rate rises will follow.
“Everybody expects interest rates to go up, but economists keep pushing out their predictions as to when they will rise, so we believe we have reached a point where the cycle will remain flatter for longer,” says Rackind. “Everyone is asking themselves about the potential impact of rate rises while at the same time dealing with the environment as it is today. There is limited oversupply and rents are not falling, yet everyone thinks we are at the end of the real estate cycle.”
Skinner agrees. “While the cycle is at a mature phase, it certainly doesn’t feel like a precipice ahead, more a plateau.”
“How you then take into account the risk of interest rate rises is the challenge all investors have got,” says Neal. “Interest rates will go up because they can’t go the other way, and yield compression is broadly over in all markets.”
Meanwhile, the trend toward protectionism in international trade provides a further complicating factor. “Germany has exports of €1.6 trillion and there are rumors that following China, the US could start looking at tariffs on European goods. That is the sort of geopolitical environment that we are trying to deal with,” observes Neal.
That leaves investors and managers trying to peer through the mists of uncertainty to identify assets with the potential for long-term resilience and growth. “Operating in this market is about having the ability to separate cyclical factors from long-term structural change when you are assessing strategy, asset class and deals,” argues McLaughlin.
No overnight fix
Appetite for assets that demonstrate structural resilience is driving interest in alternatives to the traditional asset classes of offices, retail and industrial, suggests Skinner. “I appreciate that investor interest increases when value is harder to find in other areas, but on the back of demographic change and advances in healthcare provision there is a secular increase in interest and rental prospects for demographic needs-based sectors like student accommodation and healthcare.”
Private rented sector (PRS) residential in the UK is drawing interest from investors following demographic trends, says Sugden: “The design of PRS assets is becoming more advanced and sophisticated so the quality of what tenants can rent is better, and the design side of that asset class is blurring into serviced apartments, hotels and co-working space.
Investors are offering rental opportunities to a generation that is happy to pay for that quality and is probably less concerned to buy their homes.”
Logistics continues to be the darling of many investors because of the accelerating shift toward online retail. “Thematically, industrial and logistics have a long way to go. It is about identifying the correct entry value going in as the big yield compression has already occurred,” says Rackind.
However, getting access to the property types currently in vogue at a price that allows managers to meet investor expectations is challenging, says Neal. “Some of those asset classes that people want to invest in are not available at scale, not even in the REIT market. There is no overnight fix. A lot of investors are asking us what we are doing on housing and alternative strategies. And we are moving things forward, but the stock is not necessarily there to make a meaningful immediate impact. There is a need to be disciplined, patient and to seek out operational excellence with partners.”
Finding scale in the popular urban logistics and light industrial markets is also an issue for investors, says McLaughlin. “In theory it sounds good and everybody buys into it, but getting your hands on the assets is difficult. In Central Europe, for example, we have a team of 35 people, predominantly focused on the Polish and Czech Republic markets, looking to acquire standing logistics investments. However, finding the right product is difficult. As part of that we have entered into a strategic partnership with Bouygues to develop industrial and logistics assets at yields 150-200 basis points higher than you can buy existing stock.”
Strong cap-rate compression means that, for many managers, development is the enabling strategy to acquire assets at a sensible price. “Everything is expensive in absolute terms relative to historic pricing,” says Skinner. “It is hard to make a case for any sector or any region on that basis. But in a multi-asset context pockets of value exist. We are investing in our existing assets through development and refurbishment, acquiring selectively in our preferred markets and still deploying capital for our long income strategies.”
Playing the spectrum
Are the challenges of investing in European real estate causing investors to take their money elsewhere? PERE’s own research shows that for European commingled closed-ended fund strategies $22.7 billion was raised in 2018, significantly down on the $35.6 billion recorded in 2017. Meanwhile, the latest sentiment study conducted by real estate investment umbrella bodies INREV, ANREV and PREA suggests Europe will be a net exporter of capital in 2019.
In addition, JLL figures show a decline in European commercial real estate investment volumes from €272.7 billion in 2017 to €252.7 billion last year, although it is notable that rival CBRE’s numbers show a slight increase in volumes from €312.7 billion to €313.2 billion.
The participants react with skepticism to any suggestion that investor appetite has diminished, however.
“Volumes in Europe are down not because of a lack of demand, but a lack of stock. There is insatiable demand for prime assets, but the market is bifurcated. The moment it becomes secondary or value-add, unless there is a very clear path to core, assets just sit there at pricing that doesn’t substantiate value-add risk,” argues Rackind. “Everyone tells me anecdotally that more money is being allocated to real assets than ever before, so I find that fact that the fundraising figures are down intriguing. Data does show that money is being raised by fewer managers into larger funds, however.”
“If you look at the private equity capital that has been raised for European real estate strategies and uninvested to date, it is hard to think that Europe won’t at least be neutral in terms of future deployment,” suggests Skinner. “All of the survey evidence suggests that the institutional market in Europe is likely to seek to increase its exposure to real estate, both debt and equity, with a focus on domestic European assets and a bias toward the lower end of the risk spectrum. Whether or not investors can actually deploy this year in the volumes they would like is a different matter.”
Cromwell has raised capital, following a close in December, for a euro-denominated Singaporean REIT to invest in European real estate. “There remains a strong appetite from Asian investors for European real estate,” claims McLaughlin. “For them the attraction of Europe is that the markets, while moving in the same direction, are at differing stages of the cycle. For example, they can select between, say, prime assets in Germany at 3 percent yields, or invest in a prime asset in Helsinki achieving 6-6.5 percent. They can play that spectrum – as long as they are willing to invest outside the tier one cities.”
Sugden notes that investors from Asia and the Middle East have figured prominently among Katten’s client base. “Asian money has been a bit more about UK transactions and the Middle Eastern investors have been investing equity into mainland Europe. There also seems to be a continued appetite out of Singapore right now,” he says.
Moreover, Rackind contends that Europe is also “at the top of the list” for US capital. “The US feels late cycle. Yields are rising, there is oversupply in certain major cities and rents are no longer rising, although everyone still loves multifamily,” he says. “Asia is too far, too complicated and too fragmented. US LPs look for a premium return over US investing, so if they feel US real estate is now late cycle they may also feel now is the time to move into Europe.”
Finding value in the European property market is a tough proposition at the moment, but as Skinner reflects, with increasing volatility expected in equity markets and interest rates likely to rise, few of the other havens for capital look any more alluring. “We often lose sight of the fact that we operate in a multi-asset universe. While it may be sensible to be moderately overweight in cash, where else beyond the real assets space would you want to deploy capital now?” he asks. Tight though the market may be, the roundtable participants clearly expect European real estate to continue to draw in plentiful institutional capital in the coming year.
Managing director, Europe, Cromwell Property Group
McLaughlin leads the European business of Australian-listed Cromwell Property Group. The company has total assets under management of €7.3 billion across Australia, New Zealand and Europe. In Europe Cromwell maintains 20 offices in 12 countries, managing €4 billion of real estate and investment capacity across its funds and mandates, encompassing more than 220 assets and 2,900 tenants.
Chief investment officer, Europe and Asia-Pacific,
Nuveen Real Estate
Neal is responsible for the investment oversight and strategy of Nuveen Real Estate’s Europe and Asia Pacific platform. Owned by The Teachers Insurance and Annuity Association of America, the firm was rebranded from TH Real Estate in January to bring it under the same umbrella as Nuveen, TIAA’s investment management arm. Nuveen manages $125 billion of real estate equity and debt, around 30 percent of which is located in the European and Asia-Pacific markets.
Partner and head of the real estate advisory team, EQT
Rackind heads the real estate advisory team at EQT, a multi-strategy investment firm founded in Sweden in 1994. The firm has 14 offices around the world and has raised €50 billion to invest in private equity, credit and real assets. EQT set up its real estate platform four years ago and its first fund was a European value-add office strategy.
Managing director, strategy and fund management,
Skinner heads investment strategy and fund management for the real estate business at Aviva Investors, the asset management arm of insurance company Aviva. The company operates out of offices in London, Paris and Frankfurt, and manages £43 billion of real assets, around half of which is invested in real estate equity.
Managing partner, Katten Muchin Rosenman UK
Sugden is managing partner for the London office of international law firm Katten Muchin Rosenman, which employs 700 lawyers in 14 locations. His practice is focused on real estate investment, finance and development, hospitality and leisure, real estate joint ventures and other structured real estate transactions in the UK and across Europe.
From the newsroom
The participants turned pundits to comment on some of the most thought-provoking real estate news stories to break recently
Story: Blackstone’s court battle with Italian media company RCS, which argues that the private equity firm should give back its building because it was bought cheaply while the company was in distress.
RR: It is bonkers that it has even got to court. We have an opportunity in Italy that we have paused until that law case is resolved. If this case succeeds then it means the previous owner can potentially come back and say “I want more money.”
DS: The integrity of the transaction process is based on a legally enforceable contract. If that is undermined it could put Italy into the same bracket as some emerging markets for some investors.
Story: Norwegian sovereign wealth fund Norges Bank announces it will lower its target allocation to real estate and include both listed and unlisted property in its allocation.
MN: Real estate is becoming more operational in its nature and there is a cost that runs through that. If you invest through a REIT that is exactly the same, just less visible.
DS: Most REITS in Europe are generalists. In the past Norges were pretty focused about where they wanted to be invested, down to which submarkets and streets. That is quite a big change from their very targeted investment strategy.
Story: Dallas-based investor Lone Star announces the fundraising target for its Lone Star Real Estate VI fund will be $3 billion, about half its $5.9 billion predecessor.
RR: I think it is probably a wise move if you feel there is no distress coming that will provide investment stock at scale. Investors will be very upset if it takes you three years to only invest half of their capital.
DS: If they are making that call because they do not see the opportunity to deliver the target return, that just seems like responsible investment management.
MN: There is a lot of competition and there aren’t the opportunities out there to get the scale you would have done previously.
Story: Japan’s SoftBank scales back plans for fresh investment in coworking provider WeWork.
MN: WeWork has grown exponentially to over 250 locations now in 22 countries. We believe their business case is still compelling, that they are well-capitalized and that co-working is a permanent structural feature of the market. If you go into a deal with WeWork like we did on Devonshire Square in the City of London you are underwriting the WeWork business in many respects, in addition to the real estate.
PS: It is a bit like the way people have invested in hotels historically. The investor buys a Travelodge or a Premier Inn and the hotel operator takes the operational risk.
RR: I think with the increasing number of brands in that area means there is, and will be, oversupply.
MM: Adding services to our buildings helps to create a better occupier experience. However, serviced office operators are not the solution; they, or their concept, are part of the solution.
Your last €100m
PERE asked each of the roundtable participants if they had just €100m to invest in European real estate, which asset class or location would they choose to back?
MN: Urban logistics because it is so well-supported by structural trends – digitalization, urbanization, last-mile delivery. There will be something like 75 billion internet-connected devices in play in the year 2025 and the need for distribution space will be unparalleled.
MM: I would invest in core plus and value-add office assets where there is an element of asset management needed to manage them to core – not compromising on the strength of the sub-market of the city in which they are located.
DS: Urban logistics would also be high on my list, but I would buy value-add offices in knowledge-based cities across Europe. We are very keen on the likes of Cambridge and Manchester in the UK and also Munich, Paris, Berlin, Frankfurt, Amsterdam, Copenhagen and Stockholm. If you can penetrate those markets there are decent opportunities.
PS: I will go for data centers as the adjunct to logistics. With increased automation the need for the use and storage of data is certain to increase.
RR: I think you need to follow global occupational and demographic trends, like for instance buying budget hostels in close proximity to transport hubs in tourist destination cities. Millennials and generation Z want to spend their disposable income on tourism not mortgages.