Kurt’s angles

RREEF’s global chief investment officer, Kurt Roeloffs talks PERE through his thoughts on the Eurozone's economic problems, the US debt ceiling and the competitive landscape for private equity real estate firms.

RREEF’s message to core and core plus investors: for the next five years be overweight Asia, underweight Europe and apply a neutral weighting towards the US. This recommendation was the central takeaway from the Deutsche Bank division’s Global Real Estate Investment Outlook & Market Perspective 2011, a report published Monday that makes its conclusions with reference to the invested real estate stock stipulated in DTZ’s Money into Property report. On the same day it was published, PERE visited the firm’s European headquarters in the City of London to talk through the report and RREEF’s various market and economic perspectives with its global chief investment officer, Kurt Roeloffs. Below, we present some highlights from the conversation:

PERE: What approach does RREEF take when formulating a research and strategy document like this?
Kurt Roeloffs:
We integrate a top-down process with a bottom-up real estate perspective and come out with our outlook on each of the three major global regions. The top-down process incorporates our macroeconomic views in addition to our analysis of macro real estate current conditions relative to prior real estate cycles. Our top-down process particularly emphasises risk and return; or in other words, risk-adjusted returns. We then marry this top-down perspective with what we hear on the ground from our local teams across the globe. We roll them up, compare them, and then develop our global outlook.

PERE: Presumably taking a top-down approach in today’s market is far more complicated and uncertain than perhaps the bottom up approach?
There are more ice bergs in the water now than I can ever recall Psychologically it’s easier to do the bottom-up part rather than the top-down part right now, but top-down events are going to be a major driver of what individual markets do. So you have to do both unless you are going to sit on the sidelines. Yes, there are some significantly different outcomes out there: What happens in the Eurozone? What happens to the US debt ceiling? But we have to develop a base view on what is likely to happen and then measure the spread of alternative outcomes and make a set of calls that we are willing to stand by.

PERE: You posed two pretty pertinent questions there. What are your answers?
Well I think it’s too soon to say with any certainty on both of them. However, it seems to me that the current debt pact in Europe is a temporary measure and will have to be revisited in the future.
It’s not uncommon in major crises for it to take several years to reach a complete political and social consensus about the right long-term solution. It’s hard enough to do it within one country. To do it with a dozen countries  the outcome is more important to some tan to others is actually. More to come.

PERE: And the US debt ceiling issue?
Unless there’s a major misstep, it will get solved because the consequences are just unimaginable. A compromise may simply be to kick the can down the road by increasing the debt ceiling to levels that carry the US though another six months every six to 12 months, a scenario that occurred multiple times during the Reagan and (first) Bush years. To give some perspective, there have been 74 increases in the debt ceiling since the early 1960s.

PERE: Lets move on to this week’s report itself. You say core investors should be ‘underweight Europe, overweight Asia’. Are you suggesting that investors should reduce their positions in Europe while buying more in Asia?
When we say ‘underweight Europe’ we’re not saying ‘sell Europe’ at all. But in terms of the general amount of investing you do going forward, spend a little less in Europe than you would in the US, where you should have more of a neutral weighting, and overweight Asia as you continue to build your portfolio. So these are tactical calls relative to the invested stock as reported by DTZ.

What you want to do as a private equity real estate player is stay out of the way of all that public sector liquidity
Kurt Roeloffs, RREEF

Because of Europe’s current economic uncertainty, at least right now, and the way countries in the region are responding, such as – the UK with its fiscal retrenchment and deficit reduction; the same thing happening in Spain; the different austerity packages of Portugal and Greece, and so on, the growth prospects of Europe are low and yet its risk prospects are high. For that reason we say, invest in Europe sensibly and prudently, but don’t push it as hard as you do in Asia.

Our base view is that the Euro zone won’t crumble but it may shrink at the margin so let’s manage that risk. Things will move forward with a reasonably good if not high degree of success ultimately but with some volatility in the meantime. Our conclusion is: invest but understand that bad outcomes are possible. Our view towards the US is more comfortable. While there may be some significant technical issues that bureaucrats and central bankers need to deal with the US is going to raise its debt ceiling and there is going to be deficit reduction. The US economy will grow faster on average than Europe so invest in the US and do so at a slightly faster pace than you would in Europe.

PERE: How do those views translate into a strategy for the opportunistic players in the investment spectrum?
For us, doing opportunistic investing is a lot about going in the other direction from a core investor’s strategy. Consequently, we think Europe is the most interesting place to do opportunistic investments. The banks will need to dispose of troubled loans and foreclosed real estate, governments will need to privatise state-held assets, and corporations will shed non-core assets that look too expensive to finance rather than to lease.

PERE: Of course there are a number of bank loan book sale initiatives active at the moment – we’ve recently seen sales by RBS in England and NAMA in Ireland. Is this the playground for private equity real estate firms?
When it comes to the banks and regulators, remember they are much smarter today – they’ve taken everything they learned from the early 1990s crisis and have applied it this time. Consequently, the old approaches won’t work as well. Things are different this time. There’s lots of capital in the world now – both public and private. That’s why fixed income and equity markets are where they are – except when people remember all those icebergs.

We looked honestly at our track record at what we did well, what we didn’t do so well. Then we made the appropriate adjustments and really committed ourselves to those adjustments, before going back to our clients and showing them what we’ve done and ultimately asking them: are you with us?
Kurt Roeloffs, RREEF

What you want to do as a private equity real estate player is stay out of the way of all that public sector liquidity. On the one had this liquidity has a tendency to cause returns on private capital to get compressed, and on the other hand the withdrawal of that liquidity eventually leads to negative effects. So, it is one set of strategies now when there is this excess liquidity and another set of strategies when it gets withdrawn. You have to be nimble, and its pushing everybody into refining their opportunistic business.

As a result, the big public auctions are a lot less interesting for us in this cycle. What’s more interesting from our perspective are the one-off deals and those which are lesser in scale and size. That is going to favour the mid-sized funds that don’t need to do deals in excess of $1billion.

PERE:  Let me finish be asking you how you are you reading private equity real estates’ competitive landscape?
If there were 20 players before the global financial crisis, we can see that a third of them are already out. A few very large players are definitely still in the game, and then there’s the other half of the pack, generally mid-sized, where the attrition rate is probably going to be about half.

PERE: Where do you place RREEF in that?
I would put us in the half [of the mid-sized group] that is going to succeed. We’ve really done what we’ve had to do: attended to the existing portfolios, managed our risks, did the workouts, communicate transparently with our clients and earned their confidence that we are good stewards of their capital. We looked honestly at our track record at what we did well, what we didn’t do so well. Then we made the appropriate adjustments and really committed ourselves to those adjustments, before going back to our clients and showing them what we’ve done and ultimately asking them: are you with us? And to this the response has been positive.