Despite the Fed’s 0.25% rise in interest rates in December, the medium-term prospect for rates is still low, a view backed up by Mark Carney’s recent guidance to the market, ruling out an immediate rise because of the weak global economy and slowing UK growth.
If the forecasts for a prolonged period of low growth, inflation and interest rates in the UK and Europe are correct, then the appetite for real estate as a mainstream component of institutional investment portfolios should continue to strengthen.
We believe, along with many of our peers, that despite the volatile start to 2016 and wider talk of a large market correction, any downturn in demand and/or pricing is likely to be shallow as economies and occupier demand catch up.
Above all, unlike in 2008, the Basel III grip on bank stability appears to have teeth, although the growing importance of alternative lenders does pose an element of risk.
So, what next for investment managers? As we already know, the dynamics of the market have changed significantly since the financial crisis. The era of easily achievable high double-digit 15-20% internal rates of return has become more of a memory than reality.
The IRR heroes of the future will be those investment managers that can apply sophisticated real estate knowledge to an increasingly complex range of opportunities. While the basic tools of the trade will remain the same, the opportunities will be complex, corporate or cross-border.
Overseas investors seeking high IRRs won’t simply be able to fly in at the last minute and snap up trophy assets while the competition are still running the numbers, as happened in November last year when the Filipino liquor group Emperador acquired Madrid’s Torre Espacio for €558m (£423m).
Single lots, needing remedial capital expenditure to restore them to core, also need feet on the ground. There is no question that the assessment of cross-border acquisitions calls for property expertise in each country.
We believe the focus for opportunistic asset purchases has moved from distress to complexity. Expertly managed opportunity funds, despite their reputation for risk, should beat the challenge of a correction.
To be clear, the nature of opportunistic asset acquisition has changed since 2010. Back then, it was all about acquiring distressed properties, often single buildings.
Today, it is much more about assessing complexity; taking poorly performing listed entities into private ownership; quick but able assessment of mixed portfolios held by “bad banks” and cross-border contacts and asset management capacity.
It is clear, too, that current market volatility and the prospect of a correction favour what should be a key skill for the private equity real estate fund manager: the closed-ended fund.
The ability of closed-ended fund managers to choose when to sell is a significant advantage over their open-ended counterparts, which historically have been forced into selling assets to meet redemptions during downturns.
Finally, the importance of access to local knowledge cannot be emphasised enough as a key factor leading to real estate investment success, especially for mixed cross-border portfolios of assets.
In summary, we expect the rest of 2016 to be a year of transition, with profit-taking at least equaling new inflows by year-end or early 2017.
For fund managers, as was the case during previous corrections, we will start to see a gap appear between the experienced, activist investors and the more passive investors that have benefitted from the post-crisis IRR effect.
