Next stop where?

In an increasingly tricky market, opportunity funds, with their sights set on Eastern Europe and Germany, prepare to get their hands dirty. By Philip Borel

The main message from PERE's second European Private Equity Real Estate Forum held in London in early June: Work very hard if you want to carry on making money in this asset class. The first half of the current decade will undoubtedly be remembered as a golden age of property investing, but will a 12 percent net annual return on an unlevered basis remain as readily available as it has been? Hardly, warned Matthew Ryall, a member of real estate research and strategy at Merrill Lynch Investment Managers in London who sat on the Forum's concluding panel. Without active (and clever) asset management, performance will prove elusive.

According to Ryall (who is by no means alone in holding this view), Europe's property markets are emerging from one value creation paradigm without quite being ready to enter another: Capital growth and yield compression are beginning to look like yesterday's performance drivers, meaning the low-hanging fruit have all been picked. Rental growth, on the other hand, isn't yet strong enough to take over, despite the fact that take-up levels in Europe's leading cities have been on the rise. And if you are already betting on improving rents, regardless of where in the world you are doing it, make sure you get your stock selection right. Pick the best assets in the most vibrant locations, otherwise the road ahead will be winding and long.

Underpinning the current dynamic is the fact that there are no signs of liquidity drying up, even as interest rates head north. The consequence facing opportunity funds in particular is that they continue to find themselves bidding on assets against people whose cost of capital is significantly lower than their own. As a result, “deployment rates of private equity funds have been poor,” complained one conference delegate

For limited partners pondering new fund commitments in a market this tricky and crowded, two issues deserve more attention than others: Who are the managers that can deliver alpha, and where in Europe do you want them to deploy your capital?

To answer the first question, as ever in private equity, investors rely on art and gut feel at least as much as they do on science and track record analysis. Herd thinking plays a part as well of course, so it wasn't a surprise that a number of speakers noted the growing influence of brand name bias in manager selection.

As they venture east of Vienna, practitioners will undoubtedly discover that the need for hard work and active asset management is essential to make a satisfactory return.

In terms of geography there was consensus, too. Go easy on the US or avoid it altogether. You'll need a strategy for Asia. And in Europe, have the burgeoning countries of the former Soviet Bloc covered, where GDP growth is strong while quality real estate remains in short supply. In a poll of the audience, 91 percent professed an appetite for doing business in those Central and Eastern European countries that are already part of the European Union. A still respectable 64 percent said CEE countries outside the EU were equally of interest.

As they venture east of Vienna, practitioners will undoubtedly discover that the aforementioned need for hard work and active asset management is essential to make a satisfactory return. The terrain remains treacherous; a plethora of regulatory, legal, fiscal and cultural booby traps require a delicate step and superior understanding of local conditions. John Carrafiell, global co-head of Morgan Stanley Real Estate, predicted in a key note address that from hereon, his team would focus more on finding operating companies, rather than invest in buildings directly—a change of approach undoubtedly driven by a belief that if you are putting money into increasingly exotic grounds, there really is no better way than having local people in place to look after it and help with the heavy lifting.

Alongside CEE, Carrafiell singled out Germany as another mission-critical destination in Europe. There the market remains distressed, and so an opportunity exists to buy corporate assets in bulk and well below their replacement value. For the next three years, Morgan Stanley expects to place as much as 15 percent of its ex-US capital output in Germany, which, given the firm's heft as a real estate investor, equates to several billion euros worth of investment.

Making such a bet pay off won't be straightforward, especially since Germany's economic state remains precarious. Which brings us back to the point about hard work: Next time you run into Carrafiell, expect him to have his sleeves rolled up.

RREEF closes third UK vehicle
London-based private equity real estate firm RREEF closed its third UK Property Ventures Fund on £140 million (€203 million; $255 million). With leverage, the new vehicle will have £450 million to invest and is focused on underperforming properties in the mainstream commercial sectors, as well as more peripheral areas of the property market. RREEF UK Property Ventures Fund III is targeting an IRR of 13 percent to 18 percent and has a minimum deal size of £10 million. Its predecessor invested in a wide array of properties, including gas stations, car showrooms, hotels and mixed-use facilities, while the new fund has already purchased a portfolio of 10 properties for £82.5 million.

RE pros launch new investment firm
Three real estate professionals are launching a new pan-European property investment and advisory firm. Called Pensus, the firm was founded by Hugh Elrington, formerly of CBRE; Martin Betts, formerly of Halverton Real Estate Investment Management and DTZ; and Nick Bywater, also formerly of DTZ. Alan Froggatt, former chief executive officer of CBRE, has signed on as the firm's chairman, while Esme Lowe, of real estate group CapReal, will act as a non-executive director. The firm plans to work on co-investment deals and joint ventures, with a focus on the markets in France, Germany, Holland and Belgium. It will invest in the office, retail and industrial sectors.

Report: private equity owns 14% of City offices
Private equity firms own around 14 percent of office space in the City of London, according to a new report released by Colin Lizieri and Nina Kutsch of Reading University. Titled “Who Owns the City?” the survey estimates the private equity real estate share of offices is worth more than £71 billion (€103 billion; $129 billion), whereas in 1995, private equity real estate funds only controlled 1 percent of city offices.

Finnish pension eyes more foreign investment
Finnish pension fund Pension-Fennia is reportedly planning to invest around €200 million ($252 million) in foreign indirect property, largely focusing on major European cities like Paris, Milan, London, Madrid and Frankfurt. The allocation would be around 30 percent of the fund's €600-million real estate portfolio, which is about 11 percent of the pension's overall investment portfolio.

FF&P launches new $300m Russia fund
Guernsey-based FF&P Russian Real Estate Development has announced plans to raise around $300 million (€238 million) for investments in property developments in Russia and the Ukraine via an institutional placement in Europe, Asia and the US. It is also reportedly exploring options to list on London's AIM stock market. The vehicle is a subsidiary of Fleming Family & Partners, a group that manages more than $8 billion in assets for family offices and high net worth individuals. FF&P Asset Management will be the fund's investment manager.