Despite the recent volatility across European markets, there has been significant healing over the past 18 months and the outlook for European real estate investment remains positive.
The yield premium for European commercial real estate over competing asset classes, such as sovereign bonds, has attracted strong capital inflows from around the globe. European Central Bank president Mario Draghi indicating that he is planning to increase the rate of the €1.2tn (£843bn) quantitative easing programme as early as this month, combined with new international sources of capital and backed by the prospect of rising asset values, means support for a low-cost financing environment looks set to continue
This increased weight of capital targeting European real estate means that investors are exercising even more diligence when matching strategies to assets and geographic regions in order to achieve target returns. For investors pursuing core-plus/value-add strategies, getting the composition of the portfolio right is critical.
Whether you start from scratch, purchasing individual assets to create a portfolio that will eventually trade at a potential premium from this accumulation strategy, or you purchase a distressed portfolio at a discount, with a view to asset managing it back to life, there should be three to five compelling reasons to make a trade.
We are seeing instances where groups of assets are being marketed as portfolios, but often there is no investment theme tying them together, either by sector or by geography. For us, a theme is important, but as the market moves on and the weight of capital chasing a particular theme increases, it is equally important to have the awareness to realise when a particular strategy has run its course and then have the confidence and discipline to switch it off. Also, certain themes are out of reach for some managers. For example, the potential risks associated with managing complex cross-border strategies can only be effectively mitigated by having local presence and expertise.
Ultimately, you have to be convinced by the assets. In many instances, the factors that make an asset or group of assets compelling are not immediately obvious and can be linked to aspects of the local sub-market or culture. For example, in the Netherlands we are seeing large differences between submarkets, even within the same city. In the absence of new office stock, occupiers are moving across the city for no other reason than to access a location which is closer to local amenities and transport networks; in other words, for the benefit of their employees.
As we move into the next phase of the cycle, we may see private equity investors selling assets they acquired at the low point in the investment cycle, having turned them from value-add to core-plus in the interim. Among the buyers of these assets will be institutions with longer-term investment horizons that have a lower yield requirement and are buying into a gently rising rental market.
Initially, there is likely to be a disconnect in pricing, although this will be resolved in time as there is a “meeting of minds” and the market finds a level that works for both sides. The vendors will need to factor in that much of the new capital flowing into Europe is coming from sophisticated institutional investors, many of which have experience investing in real estate. In other words, it’s “smart money” from prudent investors that will only invest when they are confident of achieving value.
Over the next six months, there is going to be a grand rotation of assets between investors on different strategies and with different return expectations. While many of the transactions will be at the portfolio level, the buyers will be characterised by investors from Europe and further afield using locally-based investment managers with on-the-ground platforms and presence.
David Kirkby is managing director, Valad Europe
