In a rapidly changing economic and political environment, and with a cyclical end approaching, investors are keener than ever to place their capital in the hands of managers they trust. In a conversation observed by PERE, Olivier Teran, chief investment officer of Allianz Real Estate, and Zahar Mejanni, advisor, Macquarie Capital, focusing on Macquarie Capital’s Private Capital Markets efforts in Europe and the Middle East, discuss some of the major issues facing investors in the private equity real estate world today. These include the current cost of assets in major cities, the importance of strong relationships in the industry and the market impact of recent events in Europe.
Pricing concerns in gateway cities
Olivier Teran: Essentially these types of cities are expensive because they attract most of the capital that is available on a global basis. At the same time, they are growing faster than the countries in which they sit plus they attract higher urbanization and therefore their infrastructure is more attractive to investors. This is why pricing in these cities is where it is. I think we are generally concerned where pricing is, at least in Western Europe. We don’t really buy at the prime yields that are reported by the agents so we have to look at deals with an “angle,” where we expect tenant demand will be very strong and therefore will drive rental growth above expectations, or where we can buy at attractive basis so then we are fairly remunerated for the risk we take.
Zahar Mejanni: Real estate markets always experience cycles, regardless of location. When we consider an investment, we start by thinking more in terms of long-term structural or demographic changes rather than just a single asset in a specific market. To get more comfortable with pricing concerns we have been more conservative in our underwriting assumptions today even compared with 12 or 24 months ago. We also focus more on develop-to-core or value-add-to-core strategies. These opportunities still provide an attractive spread and a higher initial return.
“Even if we like the sector, market or city we have to go to the asset and act with conviction; investing is an act of conviction and this should dictate our strategy in an uncertain but not totally unreadable world.”
– Olivier Teran
OT: I think it is reasonable given the low-cap environment to build downside protection and doing this also goes with taking more risk, but risk that is better priced. I agree that build-to-core or manage-to -core strategies executed with the right entry price and with the right manager in a sub-space there tend to deliver good risk-adjusted returns in an environment with very keen pricing for anything core.
Finding the right partner
ZM: When we talk about supporting the right manager we focus on supporting best-in-class, vertically-integrated managers – people who are better able to perform regardless of where we are in the cycle.
OT: We really look at two types of manager: global ones and very local ones. Once we have identified a very good manager in their sub-space and invested in their first fund, then we reupped on the second fund while slightly increasing the ticket size and then again on the third fund. As long as a manager has lived up to their promises, we back them over a longer period of time. This is also interesting because the relationship is more meaningful over time; a one-time investment is good but you don’t get much out of it except the returns. You can also diversify the product within the same relationship and therefore you are in a better place to do financing, so both sides become more relevant to each other. If there is a downturn, is it more important to be with people you understand and behave like you?
ZM: I agree. Just looking at the last five years, we have also focused more on JV or club-type deals. Many large institutional investors have had a preference not to take a back seat in a large commingled fund.
OT: At Allianz, we have been particularly active with partners these past few years we have a number of investments around the world, but we also work with regional specialists like Shapoorji in India or Lennar in the US. Once you think you’ve met the right partner, a fund is a good way to open the door and afterwards you can structure specific side-cars or club deals that you would not come across when you have not built a relationship. For an LP this is great because it means less fees but overall it enables you to do better and safer business.
ZM: This is a theme we have seen with other major global investors who want to consolidate their relationships more globally by supporting the right long-term partners, especially in sectors they have been investing in for a while. If they want to invest in new markets or more specialized sectors then they might think of fund structures or a new manager relationship.
Impact of Europe’s political instability
OT: We have gone through a sequence of elections in Europe where we avoided a massive derailing. But there have been situations like Brexit or Catalonia where it seems that the business community have only woken up after the fact. For us, we take a long view, and if we thought the UK was the wrong place to do business we would never invest there. But we have new investment strategies that have been approved recently and, when we find the right opportunities and partners, [we can] invest further.
ZM: If you look at the numbers there has been an increase of around 4 percent in RE transaction volumes over the last 12 months in the eurozone, according to RCA. This is partly because investors are allocating more of their global portfolio to mainland Europe but also shows a strong confidence in the economic and market outlook. People also expected Brexit to have a greater impact on real estate investing than it did.
OT: In the UK in 2016, investment volumes were down 40 percent; since then the pound has dropped by 15 percent so Brexit has had an impact. However, it has also created an entry point for investors in the direct private market. For me, I remain concerned because the impact of Brexit is mostly still ahead of us (at least for the London office sector) with increased concessions and the retail one that will become under pressure due to inflation.
“Just looking at the last five years, we have also focused more on JV or club-type deals. Many large institutional investors have had a preference not to take a back seat in a large commingled fund.”
– Zahar Mejanni
ZM: In the last six months the UK real estate market has been helped by the foreign exchange rate. Given where we are in the cycle globally it is even more important to back the right strategy and the right manager, and not simply buying super prime core assets without an angle or long term structural influences.
OT: Even if we like the sector, market or city we have to go to the asset and act with conviction; investing is an act of conviction and this should dictate our strategy in an uncertain but not totally unreadable world.