This article was sponsored by Ares Management Corporation • BC Partners • Kennedy Wilson Europe • Pictet Alternative Advisors Savills Investment Management • SIGNA Financial Services
In 2020, the fallout from the coronavirus pandemic jolted Europe’s real estate market and induced temporary paralysis. The result was a significant fallaway in investment volumes. According to real estate deal data firm Real Capital Analytics, Q4 2020 deals plummeted to €75.8 billion, 44 percent below the region’s peak volume recorded in the last three months of 2019. In a fate compounded by a third slew of lockdowns, that meant the total European investment volume for 2020 was 27 percent lower than the previous year.
Now, with the initial shock fading, the industry is beginning to assess the lasting effects of the crisis. Meeting by videoconference from work and home offices across the continent, the six participants at PERE’s Europe roundtable buckle down to the task of addressing the front-of-mind questions for investors in the region.
They agree that European real estate is in a better shape to recover from the pandemic-induced downturn than it was after the global financial crisis. “This time there was not overbuilding in most sectors, or overlending because banks were still unable to participate,” observes Bill Benjamin, head of real estate at global alternative investment manager Ares Management.
“There was a world of difference in the policy response this time round compared to the GFC,” adds Peter Collins, president of Kennedy Wilson Europe. “The European Central Bank was much quicker to react and so was the European Union on the fiscal side.”
Thus, following a brief hiatus in the spring, capital kept flowing into real estate, notes Zsolt Kohalmi, global head of real estate at Swiss-based Pictet Alternative Advisors. “When you have open-ended funds getting capital every month, that means that the propensity to deploy is going to remain. And as a core buyer, your returns are being measured against the risk-free rate, which is only going one way. So, on a relative basis, core looks better and better, and you keep deploying.”
While funds continued to flow into perpetual life vehicles, closed-end fundraising in Europe was a different story with plenty of instances of fundraising extension requests by managers unable to reach a final close amid travel restrictions imposed by governments. According to PERE data, $25.4 billion was raised for European closed-end funds, 12 percent more than in 2019 but 44 percent down on the region’s peak fundraising year in 2017.
Nevertheless, participants Pictet and BC Partners both raised first-time funds in 2020. Pictet closed its vehicle in February before the pandemic started. But BC Partners head of real estate Stéphane Theuriau endured the challenges of fundraising during the pandemic.
“As a new entrant our experience is that there is a lot of available capital for existing players. We raised money exclusively from existing relationships. The large managers have disproportionately benefited during this period, because it is such an easy decision for an investor to re-up based on past performance,” he says.
Capital providers were very selective about which strategies to back, however, notes Kiran Patel, global chief investment officer at Savills Investment Management. “The core end of the market became even more expensive, because people saw that as providing stability while everyone was waiting for price discovery on the more distressed areas, which did not really materialize.”
As the pandemic drags on, the initial expectation of a V-shaped recovery across the whole market has been replaced with a growing realization that there will be long-term consequences for some sectors, argues Richard Johnson, head of international capital markets at investor-developer SIGNA. “This year, we are going to be saying that the economy has split into winners and losers, which will recover at different rates, and that will affect investment flows going forward.”
The residential and logistics sectors, with their powerful narratives of resilience, have accounted for an increasing share of investment volume, says Patel. “Real Capital Analytics’ 2020 figures show that industrial has increased from 12 to 15 percent – everybody wants logistics, and that is being reflected in pricing. Residential has gone from 20 to 24 percent. Office came down from 44 percent to 40. But it was still a significant portion of the market. Retail was the big loser.”
The glut of capital demand for a few favored sectors presents investors with a dilemma, argues Kohalmi. “The real choice is which poison would you like to take? A fully priced bet where the macro drivers are right? Or an asset that faces slightly adverse conditions where you can get a better entry point? Making general calls is tough in a market with such elevated prices. We all need to find the individual deals that make sense.”
Collins senses a window for acquiring distressed assets will open briefly during the next two years. “For example, a lot of hotel operators have suffered so that could shake out some opportunities,” he says.
“But you have to get your timing right. Retail has the potential to be oversold. There are elements that will survive like convenience and retail warehousing. Overall, distress and repositioning will be the main value-add themes that everyone is playing across sectors.”
Offices under pressure
While there is broad agreement among the participants about the prospects for most asset classes, the office sector is the subject of vigorous debate. Theuriau argues that it is not only retail that will be impacted by the acceleration of technology-led disruption during the pandemic. He notes that investment activity in the office segment halved in 2020, and predicts that many occupiers will radically rethink their occupational strategies. “Technology is also attacking offices. This does not appear to be a real estate cycle or something that is driven by low GDP. If you look at offices pre-covid, it was pretty clear that there was an accelerated obsolescence, and that what qualifies as core will be a smaller proportion of what exists.”
Benjamin expects to see “a 10-15 percent erosion of demand in rents and capital value for the time being, perhaps even 20 percent.” However, he adds: “Zoom has helped our businesses during the pandemic. But we are social animals. I think productivity and morale is better in the office, and if you are starting out in any business, I do not see how you advance in your career from home.”
Nevertheless, even a 15-20 percent decline in office take-up could potentially cause huge value destruction, says Theuriau. “Cap rates are so low and rents are so high. It does not take much of a change in underwriting assumptions to get to a pretty dramatic repricing.”
Patel says Savills IM will still consider office opportunities. But he predicts the sector will go through a period of adjustment. “We do expect a price reduction, and the office sector does need to evolve. The model may become more like the retail one, moving towards turnover-based rents and shorter leases.”
While bond returns remain low, investors seeking steady cashflow and comparatively high returns have a powerful incentive to invest in core real estate. But with clouds hanging over the office sector, what constitutes a core investment in the post-pandemic market? “There are some assets that people believe in, that are priced as core, with underlying operational challenges that are not core because it is the story everybody believes. What qualifies as core now is basically residential and industrial with a huge cap rate compression,” says Theuriau.
“The more operationally intensive it is – hotels, leisure, anything where it is as much about the quality of the manager as the bricks – the less appropriate it is for core,” argues Benjamin.
The nascent multifamily residential sector in the UK and Ireland has proved its robustness when tested by covid, suggests Collins, and therefore deserves the designation. “The pandemic has proved private rented sector residential as an emerging asset class that has some of the credentials for core. It is very resilient, sticky income.”
Symptoms of change
Pictures of deserted streets in some of Europe’s capitals during covid lockdowns have led to speculation there will be an exodus from big cities and a revival of suburban fringe areas. The roundtable participants doubt there has been a lasting reversal of the urbanization trend in Europe, however.
“What was obvious traveling in Europe last summer was that as soon as people could go back to living as close to how they were living before covid, they did,” observes SIGNA’s Johnson. “People returned to offices and restaurants became full again. When considering the most resilient investments, well-located buildings in vibrant city centers like Berlin, Munich, Hamburg, Vienna and Zurich are at the core of the answer.”
“Young people who work in tech want what large cities have,” adds Benjamin. “They want good food, good nightlife, interesting streetscapes. In Europe, for the most part, those are the capital cities.”
Kohalmi argues that in Europe, unlike the US, the virus has had little impact on the which cities are favored as investment locations. “The discounts in most sectors in New York right now show a clear belief among investors that the city will take a long time to recover. We do not see that in Europe.”
He agrees with Collins that distress and repositioning will be crucial strategies in the post-coronavirus environment, and while investors may not see as much distress as they would like, repositioning will certainly be on the agenda. “There will be some fundamental shifts coming out of covid. I like the analogy with how previous pandemics have affected real estate. Central Park and the wide avenues in Paris were created to avoid the transmission of disease.”
BC Partners is hoping to harness the same trend. “If you believe the nature of demand is changing, you have to believe that investing to convert those assets is a way to protect yourself,” says Theuriau. “We raised our fund on the thesis that we were at the beginning of a big repositioning and cap-ex cycle. It is more carbon efficient than building new space, and old assets tend to be better located.”
That is “almost our business plan,” adds Johnson. “There will be effects from covid. We can see some of the symptoms of change. But we do not yet know the direction of change. If you own large blocks in the heart of cities, you control locations that are irreplaceable. It is then about finding what uses fit best for the next 10-20 years. That is where you create value.”
A hot market meant that it was already testing to deploy capital in European real estate before the pandemic. But while the crisis has further reduced the menu of palatable choices available in European real estate, and raised questions over the future of some assets, investor appetite remains strong nonetheless. For managers, meeting return expectations has rarely been so challenging.
Brexit gets real
Boris Johnson’s government signed a last-gasp trade deal with the EU just days before leaving the bloc on January 1. Now that more is known about the true shape of Brexit, the participants consider the impact on UK and European real estate
Benjamin: There is a free trade deal for most goods. But then there is anecdotal evidence of delays at the border and rotting meat. We really don’t know yet what the full impact of Brexit will be on the UK economy. However, if you are from an unstable but wealthy part of the world, Brexit is not as much of a concern, and we continue to see capital inflows looking for a home in London.
Patel: Only the goods side has been agreed. Services has not been part of the negotiations yet, so the UK has lost its passporting right of access to EU markets, and it will take time to figure out the full impact, particularly on the financial services side. That uncertainty is built into cap rates. For the first time, London prime office yields are higher than the likes of Paris, Amsterdam and Munich.
Johnson: While some of the impact of Brexit on European markets has already happened, particularly on the financial services industry in the UK, there will be more displacement toward the more attractive and well-positioned continental European cities.
Collins: The EU authorities have an ambition to make the bloc more self-sufficient in financial services. They will try to move some activity to Europe. Instead of one European market emerging as a clear winner, that displaced demand is getting dispersed around. Some of it is going to Dublin, some to Luxembourg, some to Amsterdam among others. Relocations will be positive for those smaller cities. But given the scale of London, I doubt that any major financial services impact of Brexit will be visible there over a one to three-year period – 10 years is more likely.
Theuriau: We are seeing the fundraising activities of some very large players move to the EU. Luxembourg, which has been very successful as a domicile to provide EU substance, will benefit further. The big loss for London is its tax advantage for bankers and fund managers. However, I believe its appeal will endure because of its finance culture and talent pool. Also, Boris Johnson has no choice but to make London attractive, so he will probably bring back the tax advantages.
The envy list
Which deals did the participants wish they had done in 2020?
Kohalmi: Ares pays SFr150 million ($169 million; €140 million) to become a 30 percent shareholder in German residential manager Peach Property Group. “I will give Bill’s firm my vote. Accessing real estate through the public markets was quite attractive in 2020 because there were discounts available and it was a way to play in markets that were paralyzed for a time.”
Collins: AXA Investment Managers Real Assets’ purchase of Dolphin Square, a neo-Georgian private residential complex in London’s Pimlico, from Westbrook Partners. “For long-term capital it was a great deployment. Multifamily is all about scale and they have more than 1,200 units there. London will survive and thrive in the long term; the rents look like they can be grown, and there is clearly a long-term refurbishment play there as well.”
Theuriau: Real estate investor Léon Bressler and French telecoms billionaire Xavier Niel win the support of Unibail-Rodamco-Westfield shareholders, who vote to halt the shopping center operator’s €3.5 billion rights issue and grant their consortium three seats on the company’s supervisory board. “The way they played the chessboard so rapidly to convert a difficult position into taking control of what used to be a €30 billion market-cap company was fantastic.”
Patel: German investor Deka Immobilien buys the Südkreuz office development in Berlin for around €270 million. “That was one that got away. It was part pre-leased, which would have enabled us to take some leasing risk, and had a very high ESG rating. But our exclusivity period ran out and we lost out to Deka, which ended up paying 15 percent more for it, which shows what a good deal it would have been.”
Benjamin: Brookfield Asset Management buys a £264 million ($365 million; €301 million) stake in British Land, one of the largest UK REITs. “I wish we had bought British Land and [fellow UK quoted property company] Landsec when their shares were at their nadir. The paper was definitely cheaper than the bricks at that point.”
Johnson: AXA Investment Managers Real Assets acquires Kadans Science Partner, a developer, operator and owner of European science parks, from Oaktree Capital Management for around €500 million. “Any investor expanding into life sciences pre-covid, before the pricing went up, would pat themselves on the back. It is a really interesting new type of asset that could well become core over time.”
Meet the participants
Partner and head of real estate group
Ares Management Corporation
Based in London, Benjamin is head of real estate at global alternative investment manager Ares, where he oversees the real estate group’s investment activity worldwide. The firm manages around $179 billion of assets, primarily in the private markets, including $14.4 billion of real estate in opportunistic and value-add strategies in Europe and the US, and in US real estate debt.
Global chief investment officer and deputy global chief executive officer
Savills Investment Management
Patel joined Savills IM, the investment management arm of global real estate services provider Savills Group, eight years ago. The business manages around $25 billion of real estate assets, employing a team of 300 professionals located in 16 offices across Europe and Asia.
Global head of real estate and co-chief executive officer
Pictet Alternative Advisors
Kohalmi joined Pictet from Starwood Capital two years ago to build the Swiss financial services firm’s real estate business. Pictet manages €560 billion overall, including around €4 billion of real estate. The company closed its first direct real estate fund, Elevation I, at its hard-cap of €700 million in February 2020.
Kennedy Wilson Europe
Collins has been with global property company and investment manager Kennedy Wilson since 2011 and now leads its European business. Quoted in the US, the firm has $17 billion of assets under management in strategies that span the risk spectrum from development to core-plus and sectors including offices, multifamily and industrial.
Partner and head of real estate
Paris-based Theuriau joined BC Partners in 2018 to launch the company’s real estate business, and has led an €800 million fundraise for its first real estate vehicle. The London-headquartered firm manages around €25 billion of assets overall, principally in private equity and credit strategies.
Managing director and head of international capital markets
SIGNA Financial Services
Johnson joined SIGNA two years ago to expand the Austrian-headquartered group’s connections among non-German speaking institutions. The privately managed investment and holding company’s real estate division manages around €18 billion of standing assets and is undertaking €12 billion of development in Austria, Germany, Switzerland and Italy.