This article was sponsored by MIRA Real Estate. It appeared in the Global Investor 50 special section alongside the November issue of PERE magazine.
Ambiguity over Brexit and a slowdown in the German economy have overshadowed European real estate markets in recent months, although properties continue to trade for record prices.
The expectation of continued low or negative interest rates across much of the continent will continue to underpin high values and elevated levels of transactional activity, even while growth expectations are moderate, according to Karim Habra, head of Europe at Ivanhoé Cambridge; Zahar Mejanni, MIRA Real Estate’s head of private capital markets EMEA; and Olivier Téran, chief investment officer at Allianz Real Estate. PERE’s Stuart Watson listens in to their discussion.
European property as part of a global portfolio
Olivier Téran: We’ve been growing our business in the US and have seen significant growth on the equity side in Asia-Pacific in the past 18-24 months, but as a euro investor we look at our home markets first, so Europe remains the main focus. There are also some asset classes like student housing that we think of on a global basis.
Karim Habra: Being a North American investor, the situation is the reverse for us, but the ultimate goal remains the same. Europe and APAC are our top priorities for our growth and diversification strategy worldwide mainly in the value creation space. Of course, we also have global priorities product-wise, like investing more into logistics or innovative real state products.
Zahar Mejanni: Our focus is more structural than geographic. We like to invest in asset classes with structural tailwinds driven by urbanization, demographics or technology. Europe and the US remain an integral part of a balanced global portfolio but we also continue to see an increased focus on Asia-Pacific, both in growth and developed markets.
Late-cycle or end-cycle?
OT: We’re still seeing positive rental growth dynamics in some of the office markets and a very active investment market, and our view is that we are late-cycle, but not yet end-of-cycle. What that means is we have to be more cautious. We are focused on resilience, making sure the product is in the right location and is the right asset for the long term. Because of the way our capital is structured we are very long-term investors, so unlike a closed-end fund we don’t need to consider time-limited exits.
KH: We are conscious that the market in Europe is at a late stage of the cycle but we don’t know how close we are from the end of it. What we can see however is that new supply for quality assets still remains limited and occupier demand continues to be strong. Our ambition is to grow our European exposure and the best way to protect ourselves is to focus on the right locations and build sustainable products for the future with the right environmental standards and the right technology addressing the current and future needs of our tenants.
ZM: We believe it is late-cycle and that guides our investment decisions. Similar to Ivanhoé Cambridge and Allianz, our partners are long-term minded and look beyond short-term cycles. It is worth noting, however, that every other cycle is usually less pronounced than the previous one, and investors are currently using less leverage than they were in the previous one. Elevated property spreads to government and corporate bonds will also provide some protection for values.
Negative European interest rates
OT: The low interest rate environment is an issue because you have significant negative yielding debt in the marketplace and bond portfolios no longer produce the yield investors want, so they increase allocations to alternative sectors like real estate. They are willing to accept lower yields in real estate because the alternative of negative yields is even worse.
KH: What would be more important to us is how stable they will be in the long term so we can continue to focus on our build to core and value creation strategies which is the DNA of Ivanhoe Cambridge. In our view, risk premiums over long-term funding costs are presently too thin to buy core assets. Prime yields are at record lows and rental growth is starting to to slow down. Consequently, we are a seller of core products, for which value has already been fully extracted or created. However, because yields are low, core buyers are looking to generate higher returns and we see them entering the core-plus and value-add segments, which increases competition for that space of the market.
Impact of Brexit
KH: We’re waiting to see what happens and we are especially cautious on the London office market at the moment, but that doesn’t prevent us from preparing ourselves or from looking at what could be done in this market in the future. Our European investment strategy focuses strongly on France, Germany and the UK – mainly in Paris and London for offices – because we believe in their respective strong fundamentals. We added two people to our London team this year despite Brexit, and in March our PLP logistics joint venture with MIRA Real Estate and Peel Group acquired four development sites in the north of England with a projected value of about £300 million ($385 million; €346 million), because we have a positive long-term view on the UK logistics market.
ZM: Overall, UK transaction volumes are down by about a third when compared to the period prior to the EU referendum. However, large institutional investors remain active in the market and in many cases have been investing further. We have seen this playing out in the logistics and rental accommodation sectors. We expect to see more activity in the office sector once there is more certainty around the UK’s departure from the EU. Any softening of Brexit risks would be a clear positive for UK commercial real estate, including pricing and transactional activity.
OT: The uncertainty around Brexit is understandable, but that doesn’t mean there aren’t opportunities for long-term investors. London is ranked among the top five cities for core office investment in our 2019 Cities that Work report – though in just position 10 for value-add – and we believe London will sustain itself with or without Brexit.
We also see London as much more than an investment opportunity, which is why we opened an office there this year as it strengthens our global footprint and helps us drive more origination for cross-border deals, because many investors are London-based, something we expect to continue in the long term.
From an investment perspective, our UK footprint is quite small, but alongside our well-established European debt portfolio – which has a strong office allocation – we’ve made logistics investments in the UK and will continue to build our student housing portfolio in London. We’re also looking around the UK for build-to-rent residential opportunities.
German economic growth stalls
ZM: Germany’s real estate market is deep, growing and resilient. However, its export-dependent economy is naturally impacted by the global trade uncertainty of the past year. We expect that there will be a resolution on the trade negotiations in the short term and the German economy will benefit from that. Any policy support from China or some resolution of US-China trade wars over the next 12 months would be a clear positive for Germany and the Eurozone’s manufacturing sector given strong global trade linkages.
KH: We’ve been in Germany for a while but we sold some assets there in past years and we are now trying to increase our exposure again. The German economy is slowing and and the best entry date is now past. However, we strongly believe in the Berlin office market, which is why we picked it as the location to open our German office. We’re seeing many interesting value creation opportunities there, but also in some of the other top seven German cities, and we still see rental growth potential in the right locations for the right products. Berlin in thriving and benefits from stronger demographic growth prospects compared to other German cities. Its economy is also less dependent on the manufacturing sector that is being affected by the current global trade slow down.
OT: We still see Germany as attractive, with Berlin at the forefront followed by Munich and Frankfurt; Munich is the number one German city in our Cities that Work analysis. Core product is remains our main focus in Germany, but it’s becoming increasingly expensive and we’ve been growing our value-add assets under management.
Predictions for 2020
OT: I don’t think there will be much difference between this year and next. We’ll see a prolongation of the late-cycle market. Interest rates will stay where they are or move slightly downward while slow economic growth continues. We’ll see downward pressure on cap rates on the core side as investors search for yield that they cannot find in the bond markets. That will keep money flowing into the core sector.
KH: I don’t expect radical change either. The UK suffered this year from Brexit uncertainty and hopefully in 2020 we’ll see some more opportunities in that market. There will be a lot of core buyers so there may continue to be pressure on yields for core product. The flipside of that will be more appetite for value-creation strategies. There will be continued strong interest in logistics because the sector benefits from strong fundamental trends and its assets offer higher cash-on-cash returns than office or residential, which is valuable for many investors.
ZM: Interest rates will likely be low or negative across Europe in the short term, so real estate cap rates will remain tight. Based on modest expectations for regional economic growth, attractive property spreads will continue to draw capital into major European markets. Core real estate in supply-constrained markets remains attractive for long-term investors wanting stable cash flow across cycles. Logistics and rental accommodation will also remain preferred sectors for investors given solid demand drive.
Sustainability a high priority for investors in Europe
Allianz and Ivanhoé Cambridge back high-tech green office towers in Paris and Berlin
“There will be more focus on sustainable buildings in the long term,” predicts Ivanhoé Cambridge’s Habra. “We can see investor priorities shifting toward that already.” Allianz’s Téran concurs: “It’s going to be a huge focus and topic of conversation in the next years.”
Both investors are backing high-profile development projects in European capitals with a strong emphasis on environmental performance. Ivanhoé Cambridge is funding the construction of DUO, a scheme consisting of two asymmetrical towers, 27 and 39 stories high in Paris’s 13th arrondissement. One will provide a home for Natixis, the international corporate and investment banking arm of French bank Groupe BPCE, while the other will include a hotel and retail space. Construction is underway with completion due in 2021 and the project is aiming for LEED and WELL platinum certifications.
Meanwhile Allianz announced in September that it had acquired a 35-story office tower in Berlin from developer EDGE Properties. The project will be forward funded by several Allianz group entities and Universal-Investment, acting on behalf of a real estate fund launched for German pension fund Bayerische Versorgungskammer (BVK). The 700,000 square foot building, which will be completed in 2023, is also aiming for the highest environmental ratings. “We are very proud of that building because it makes extensive use of smart technologies,” says Téran. “It is also one of our first deals to use third-party equity, and is part of a drive to grow our third-party business to €10 billion by 2024.”