Market risks are less and less acceptable

Senior executives from BlackRock, Hines, M&G Real Estate and AXA Investment Managers – Real Assets told PERE’s panel at EXPO Real investors would rather take lower returns than see their managers bet on riskier markets.

It was not long before PERE’s panel at EXPO Real turned to risk-taking – or, more specifically, the avoidance of risk-taking.

The panel comprised Lars Huber, chief executive for Hines Europe, Thomas Mueller, managing director at BlackRock, John O’Driscoll, European head of transactions at AXA Investment Managers – Real Assets and Peter Riley, deputy fund manager at M&G Real Estate. In aggregate, they manage approximately $270 billion of assets across geographies, asset classes and risk profiles.

In a decidedly capital markets-oriented discussion, PERE opened the 50-minute session with statistics underpinning increasing investment volumes for the asset class globally. JLL, the broker which predicted a 5-10 percent decrease at the turn of 2018, has since revised its forecast to $715 billion year, a total that matches last year. In the region of most relevance to EXPO Real’s broad real estate audience, Europe, JLL recorded $67 billion of investment in Q2, up 11 percent year-on-year, bringing the half to the highest volume in the current cycle – despite geopolitical issues, economic uncertainties and the other various disruptions affecting the private real estate asset class.

In the absence of a detectable catalyst for a downturn, volumes are expected to continue an upward trajectory. The panel pointed out investment cycles in Europe depended on specific asset classes and geographies: certain office markets are at the late stage while urban logistics and rented accommodation, early. Many retail markets, on the other hand, are going sideways as consumer dynamics take their toll. Geographically, Greek hospitality is at an early stage, German prime offices late.

Speaking generally, though, Mueller said: “We’re in an environment with strong real estate fundamentals which has elevated pricing. Looking across Europe, I see strong growth, low rates and rental growth coming through. As a value investor, I’m liking the long-term average yield spreads between core and non-core. Taking all that into account, I think we have quite a bit of runway ahead of us.”

Riley added: “We’re investing in real estate suitable for end-users like hospitality and last-mile logistics. These have become very important because sectors like these you could describe as being early in their relative cycles.”

The panelists concurred they had plenty of investing to do, even at this current, lofty point in the cycle, underscoring the likelihood of greater total volumes in the near term. But with that will come further yield compression. Investors do not mind, Mueller said: “When we opened our last fund, target returns were 13-16 percent net. We’re about to launch a successor fund and that return is now 12-14 percent net. Unequivocally, the feedback we get from investors is ‘we don’t want to take more risk in the current context so, yes, we’re happy for lower returns’.”

“Take no risk on location at this point in the cycle. That’s the highest risk you can take. It’s the one thing you can’t react to when markets turn against you”

-Lars Huber

For Hines’ Huber, one clear method of mitigating cycle risk is to ensure no location risk is permitted. “Market risks are less and less acceptable to investors,” he told the audience. “Take no risk on location at this point in the cycle. That’s the highest risk you can take. It’s the one thing you can’t react to when markets turn against you. Buildings in secondary locations suffer first and most when they turn and that’s where most the equity losses will be seen.

When PERE suggested secondary market descriptions are, however, prone to redefinition as managers strain to meet deployment pressures, Huber agreed: “Totally. That’s what happens in this late part of the cycle. Definitions get softer and areas once considered a no-go are moved upon for a perceived higher return. Of the losses we made after the financial crisis, 90 percent came from investments made in secondary locations too late in the cycle. There’s a clear lesson learned to stay away from these.”

Mueller added: “Liquidity is not just in terms of location, but also lot size. We’ve clearly defined the most liquid lot sizes in each the cities we’re investing in.” He exemplified Hamburg’s most liquid office assets to be in the €60 million-€70 million range, while in Munich, assets of €200 million are highly liquid.

At the end of the session, PERE challenged the panelists to pick markets they could classify as best performing, an outside bet and clearly challenged. The outcome was consensus on strong returns from housing investments and poor performances from retail. The most popular dark horse? London offices

Ultimately, just as investors are instructing their managers to stay disciplined and deploy in liquid, prime markets, managers are largely compliant. As AXA’s O’Driscoll said: “Things that are clearly prime and touching demographic structural trends are the right kinds of opportunities that are being targeted today