As a tsunami of capital inundates Europe’s real estate markets, there is a danger of being swept up by talk that “now is a great time to be buying real estate”. If only it were that simple.
When European Central Bank president Mario Draghi said in 2012 that he would do “whatever it takes” to save the euro, it triggered a seismic shift in global capital markets. Real estate is a particular beneficiary. The ECB’s bond-buying programme of quantitative easing, against a background of negligible inflation, has ushered in interest rates that are hovering at, or close to, historic lows. This has created a massive appetite for hard assets that produce an income – the higher yielding, the better.
The sheer weight of capital chasing prime property assets has powered price gains, compressing yields in core markets and boosting investor interest in higher-yielding sectors of the market.
For light industrial or multilet properties there is a differential of some 700bps between the ultra-low cost of borrowing and unlevered property yields. Such pricing reflects a very different risk profile than, say, an investment in a trophy building occupied by a triple-A-rated corporation on a 10-year lease. These higher-yielding properties are mainly occupied by small- and medium-sized businesses, and so they are characterised by a regular churn in tenants and require active asset management. Investors need the requisite operational capabilities and know-how to ensure that these properties keep generating their target returns, or to work with a partner that does.
One of the main lessons of the 2008 crash was the importance of liquidity. Take it from someone who experienced first-hand the destruction caused as liquidity evaporated. It is why, in our specialty sector of multilet, higher-yielding property, M7 Real Estate is prudent in its own balance sheet investments, joint ventures with private equity and institutional capital providers, and as an investment manager for third parties.
Capturing what turns out to be a peak price for property investment is as much down to luck as skill. Unlike currency, fixed-income and equity markets, where trades are executed in seconds, it can take months to complete a real estate transaction.
For this reason, we look to sell properties before liquidity dries up. It is why we are shifting to becoming a net seller of the properties we bought in the UK at good prices in 2009 and 2010. Yields in our sector have compressed by 200 to 300bps and the bid-offer spread for properties is getting wider as asking prices get further removed from transaction pricing. That does not mean that there is no value left in the UK, but it is harder to find, limited to pockets of the market and requires investors to be more imaginative in how they approach deals.
We see the largest markets of continental Europe as offering more attractive opportunities for investors in light industrial and high-yielding, multilet property. We favour investing in Germany because of its strong manufacturing base and the Netherlands, as an export hub. Both will benefit most from the euro’s relative weakness and as the combination of low interest rates and inflation enables economic growth to accelerate. We are more cautious about the French market because of its political and economic challenges, while the eurozone periphery presents a different type of opportunity.
Continental European banks have been slow to address non-performing loans on their balance sheets, so improvements in asset pricing mean they are more likely to cut support for those “broken” managers or owners. There is a steady flow of properties and portfolios onto the market suitable for acquisition, or to be asset managed by specialist pan-European platforms.
This window of opportunity will probably last for the next two years, although in Germany there are signs that it may close sooner. With the liquidity imperative in mind, we have modified our approach to the funds we establish so that third parties can invest in high-yielding European property. To ensure that money is put to work at once, we look to structure funds specifically for each transaction. How many of these asset-specific vehicles we end up advising will hinge on the opportunities and liquidity in the market.
Timing an investment is critical, which is why following the herd into real estate demands rigorous critical thinking, particularly where liquidity is concerned. As Warren Buffett said famously in his 2001 letter to Berkshire Hathaway shareholders: “You only find out who is swimming naked when the tide goes out.’’
Richard Croft, chief executive, M7 Real Estate
