FROM THE FRONT LINE
Four real estate professionals examine life in the Eurozone as the region’s economic prospects continue to dominate the headlines
RREEF Real Estate
Metropolitan Real Estate
Hodes Weill & Associates
International investors are still wary of committing to higher-risk strategies in Europe, but they are slowly creeping back.
It is Monday 27 February, and four London-based real estate professionals are sitting around a table discussing the latest themes in European private equity real estate. Everyone is thinking about the economic situation in Europe, which has been affecting everything from fundraising to investments. However, for Chris Papachristophorou, managing director of RREEF Real Estate and head of opportunistic investments, there is an added dimension – corporate uncertainty.
Having kindly agreed to host the discussion at its offices in One Appold Street, RREEF Real Estate could soon be owned by another organisation. Indeed, the day after the roundtable, Deutsche Bank announced that it had entered into exclusive talks with New York- and Chicago-based Guggenheim Partners to sell certain parts of Deutsche Bank Asset Management, including the real estate business.
For the other participants, there are less profound corporate transitions to take into consideration. Present are Dominic Field, a partner at Hodes Weill & Associates responsible for managing the business activities of the firm in Europe, including coverage of institutional investors and investment and fund managers. Seated next to him is Jeremy Ford, senior vice president at Metropolitan Real Estate Equity Management responsible for identifying and evaluating investment opportunities in Europe and the UK. On the other side of the table is Nigel Hatfield, a partner at Clifford who specialises in private investment funds, including advising on the structuring and marketing of them.
In essence, there is a general partner and opportunistic fund manager in RREEF Real Estate, an advisory firm /capital-raiser in Hodes Weill, an indirect investor in Metropolitan Real Estate and a law firm in Clifford Chance, each giving different perspectives on the same industry.
Opportunity amid uncertainty
Setting the scene, Papachristophorou says there currently are two dynamics at work that actually contrast each other. On the one hand, he genuinely believes that, over the next couple of years, there will be unique opportunities in Europe. At the same time, the uncertainty surrounding the Eurozone is affecting investors, who have become very cautious in deploying capital, at least in the short term. Indeed, that juxtaposition is really the backdrop to the entire discussion, with every point flowing from it.
Metropolitan Real Estate’s Ford says, from his perspective, there has been a noticeable change in the way US investors perceive Europe. Last year, US investors began taking notice of Europe again because of the volatility unfolding, even if that interest wasn’t yet being converted into investments due to concerns about the macroeconomic environment. He notes that real estate transaction levels have been low, but they are beginning to pick up. Therefore, now is when investors should start lining up their commitments to be ready to take advantage of investment opportunities, he says.
Explaining more about the oscillation of investor sentiment that has taken place these past 12 months, Papachristophorou says last summer was the first time his firm started seeing investor interest returning to Europe. However, when Italian and Spanish bond yield spreads seemed to suggest a doomsday scenario of total Eurozone collapse, a lot of unease crept back in. Now, with countries beginning to agree to game plans to address national debt, some comfort is returning. Transforming interest into commitments is something RREEF Real Estate is seeing now.
Hodes Weill’s Field likens the European real estate markets to a hospital drama, in which the patient is in intensive care without anyone knowing how long the recovery will be. “We know the patient will survive, but how long will the recovery be and will they retain the same character afterwards?” he asks rhetorically.
Fields’ point is that the situation is not as simple as the examination of one single market. Rather, being a heterogeneous zone, Europe is made of up of many, very different markets. Nevertheless, he feels the general trend – albeit slowly – is towards more transactions. The un-invested cash within the institutional investor community is waiting to get invested, he notes, and could resurface in joint ventures and separate accounts, as well as commingled funds. “Institutions need real estate, and there are limited ways in which they can get exposure,” he adds.
A matter of structure
How capital surfaces in Europe is a profoundly important question at this time, particularly as many institutional investors from within the economic zone still appear reticent to become involved in real estate funds to the degree they were before the global financial crisis reared up in 2008. Frankly, many got burned from the experience and, if there was ever a love affair with private equity real estate in the first place, that passion is gone.
Still, the roundtable participants certainly are not ready to read the fund model its last rites. Field argues that the fund model has survived, although he concedes that the investment levels of 2005 and 2006 are nowhere to be seen. Still, his position is that there are indeed investors out there for the right fund, team and strategy.
Clifford Chance’s Hatfield is as well placed as anybody to observe the changes that have taken place in popular fund structuring practices, given that he heads up a group that advises on doing just that. Last year, for example, the firm advised on a number of high-profile real estate fundraisings in the UK, the US and across continental Europe.
Hatfield notes that fears over the Eurozone are beginning to gradually recede, but he says, apart from a few institutions with “gutsy strategies,” investors are still on a “slow track.” Extrapolating views from clients for which his firm works, he notes that there is a twin-track market, with some markets such as the UK, Germany, France and the Nordics seen as good places to invest while Spain, Italy and Eastern Europe are viewed as more risky.
This prompts Hatfield to suggest that the concept of a pan-European fund has been off the radar for a little while. That said, he feels the fund model is coming back, albeit at a slow pace. “If anyone says they are raising a fund quickly, they are not being entirely truthful,” he adds.
With regard to club vehicles, co-investment vehicles and separate accounts, Papachristophorou offers strong views about the alternative structures. While RREEF Real Estate is being flexible with the sources of capital it is getting, he questions just how many of these structures actually happened. Moreover, he points out the potential shortcomings of club vehicles, such as flexibility. “When it is Christmas Eve and you are looking at an opportunistic deal where flexibility and time is of the essence, are you going to go back and ask five club members to do a deal?”
After some debate about how investors have in recent times been turned off from the fund model because of previous poor performance or because of “skiing off-piste,” as Hatfield put it (meaning style drift away from the original stated investment aims of a fund), there seems to be consensus among the participants that the result has been that investment policies and restrictions are being focused on much more in fund documentation. That should indeed improve matters somewhat, given that increased attention to such things has led to better-defined investment parameters.
That said, RREEF’s Papachristophorou argues that managers that can play across a variety of markets would have an advantage over a country-specific manager in the medium to long term, even though investors do want to see a precise and more narrowly defined investment strategy.
Noting the number of pan-European opportunistic funds coming to market in 2012, Hodes Weill’s Field takes the view that it isn’t the fact that a fund was pan-European that led to lacklustre performance. Rather, it was other factors such as the global financial crisis creating a major re-pricing during the investment stage of earlier vintage funds.
Almost as an aside, Papachristophorou says RREEF’s opportunistic platform will do less with local operating partners, given that it has built up experience in the core markets in which it has been operating. That, in turn, sparks a mini-debate among the group.
In Europe, because of the nature of its very different markets, many firms have taken to models that revolve around partnering with a local player to locate, assess, execute and help manage investments. Problems have emerged with that model during times of strain.
Metropolitan Real Estate’s Ford says that, as part of his firm’s due diligence and investment monitoring of a manager, it will meet with some of the manager’s operating partners. That could be in the form of attending an annual meeting where the operating partners are present, meeting with the partners in their local markets or meeting at the manager’s main office. “We seek to build a portfolio with local experts,” he says. “However, we also will seek select exposure to non-core European countries, like Spain. It is unlikely you are going to go into one of the non-core markets and make a commitment directly at this point in time, but you might invest with a pan-European manager that will invest in core European markets but also will provide you with the opportunity for some exposure in, say, Central Europe or southern Europe.”
Ford adds: “We look at the full range of opportunities and focus on major markets such as the UK, where the depth of managers is quite deep; Germany, where there is an increasing number of managers; and France and the Nordic region. We will, of course, look at managers that are Spain only or Italy only, but it is much tougher in this environment because, in some of those markets, you might not want to be investing at a given point in time. However, I will say that, with a three- or four-year investment period, there are likely to be opportunities for pan-European managers to invest part of their capital in non-core markets.”
The bank pipeline
Having spent time mulling the pros and cons of fund structures, pan-Europe versus country-specific vehicles and operating partners, deploying capital becomes the next topic to dissect. After all, no one is going to get very far in this business if managers cannot put their equity to work effectively. For the participants around the table, this naturally means a discussion concerning the banks in Europe, both as financiers to real estate funds and as potential sources of deal flow given that they are deleveraging their balance sheets.
Metropolitan Real Estate’s Ford is the first to address the issue. Having explained that European banks generally have been slower than American ones to dispose of their holdings, he says the banks now see that something needs to be done given the wall of maturities and coming regulations. He notes that large portfolio sales and smaller “one-off” sales are starting to take place and estimates that the opportunities will be coming not just over the next months but the next few years as well.
In addition, Ford points out how the banks are approaching their issues differently from country to country. Indeed, some transactions have been highly structured, such as the £1.4 billion (€1.54 billion; $2.24 billion) Project Isobel, which involved Royal Bank of Scotland selling down a stake in a large loan pool to The Blackstone Group. This and other one-off deals by banks entertaining profit-sharing arrangements have shown that “it is about having the proven ability to do something with the property and having the relationships.”
As the main man around the table with direct responsibility for doing deals with financial institutions such as banks, RREEF Real Estate’s Papachristophorou notes that many clients have been asking about distressed debt situation and whether it is the unfulfilled opportunity/theme of the century. On that matter, he agrees with Ford.
“It is a fact that European banks were more reluctant to take their losses upfront,” Papachristophorou says. “If you look at some of the deals that happened in 2008, it was mainly the US banks that were trying to exit. Very few European banks did the same. At that time, the European banks felt economies would recover. There was a very low interest rate environment, so they decided to ‘extend and pretend’. That strategy was working because, if you look at the first six months of 2011, the European economies were improving and there was belief that people would be able to refinance and/or sell assets, therefore incurring less losses. However, things actually became much worse.”
A deteriorating macroeconomic environment, deteriorating portfolios and approaching loan maturities conspired to make everything “go the wrong way” in the latter part of 2011. Now the new question is, given that banks have had to take large write-downs on their sovereign bond holdings, are they able to sustain additional losses from the sale of property portfolios?
Papachristophorou says Ford’s earlier comments are right on the mark. German lenders are retreating to their home market, and they are more open to take losses in peripheral markets where they have been selling down and/or get involved in structured deals where they can find a new manager to inject fresh equity. Indeed, RREEF Real Estate currently is looking at one or two such structured deals itself.
Papachristophorou hopes that banks have become more stable though the European Financial Stability Facility, whose objective is to preserve the financial stability of Europe’s monetary union by providing temporary financial assistance to Eurozone member states if needed. If banks become more stable, he reasons, perhaps they will be able to afford to conduct larger property trades. “It will be case by case, but banks also have Basel III to consider soon,” he adds.
The funding conundrum
Still, if banks do get into a position to sell more, who is going to finance the acquirers of their real estate? It is a thorny issue, and the next one those around the table address.
RREEF Real Estate, along with other firms, no doubt has found itself looking at assets priced upon unlevered returns, making them uncompetitive. Indeed, such a scenario occurred with a portfolio the firm looked at in the Netherlands.
As Clifford Chance’s Hatfield points out, the lack of debt has led to certain groups creating debt funds precisely to satisfy the need for liquidity. Hatfield has worked on some himself, and there are more groups talking to Clifford Chance about this area. “Five years ago, there obviously wasn’t this kind of activity, but now a lot of people are coming through talking about these things to take up some of the funding gap left by the banks,” he says.
It is certainly not surprising that groups would look to seize on lending as a credible strategy nowadays. As Hodes Weill’s Field says, while there seemed to remain some uncertainty in the underlying real estate markets of Europe, getting a potentially strong income dividend from debt instruments and thus diversifying risk (and potentially ending up with control of the asset) is an interesting route to go down.
Overall, it is reassuring to hear from the participants that, from a classical perspective, the fund model might be coming back, whether they are debt funds or more direct property vehicles. Given the uncertainty in Europe, challenging real estate financing conditions, the popularity of core property and all the other factors counting against opportunistic investing, there still are predictions of a gradual move back towards the “classic blind-pool model,” as Hatfield calls it.
“There won’t be a sudden move, but we are going to see an increase in the number of funds, in particular in the opportunistic space,” Hatfield says. “It is trending in that direction, together with debt funds and an increasing number of secondaries in the marketplace, as the valuations between seller and buyer gradually converge.” The downside is that regulation and increased investor due diligence and negotiation is going to make the whole process of fundraising more cumbersome.
In the slip stream of Hatfield’s comments, Hodes Weill’s Field says he thinks there will be a lot of fundraising opportunities and that the fund model will remain intact, as he said earlier. “I think we are on the road to recovery, which is encouraging,” he adds. That is certainly good news for his firm, which is transitioning from advisory work to taking on fundraising mandates. It has opened new offices in London and Hong Kong in anticipation of such work and is now manned with many of the original members of Credit Suisse’s real estate private fund group.
From an investing perspective, Metropolitan Real Estate’s Ford sees no lack of opportunity. “There has been significant growth in fund opportunities over the past five years, with individual markets becoming deeper with local players,” he says. “Still, we remain focused on evaluating opportunities in the major European markets, as well as managers looking at well-located, in-fill properties and managers that will be able to take advantage of the deleveraging that the banks need to go through. We expect that deleveraging will generate opportunities that we will be able to invest in over the coming years. As I said at the beginning, we are optimistic about the opportunities, but they will evolve over time.”
Last but not least, Papachristophorou says: “As far as the opportunities go on the investment side, we will look at things where we feel we have a competitive advantage. We are extremely selective in the opportunities we are pursuing and very focused on our investment themes. At the same time, we do have flexibility with our sources of capital. Although I do believe with some improvement that the traditional fund model is the way to go, at least in the opportunistic space, one does need to remain flexible and adaptable to the needs of investors.”
Papachristophorou notes how RREEF Real Estate has done exceptionally well in the markets where it has a strong local presence. “We will look to maintain that and retain stability in the platform,” he says. “Still, we are ready to go wherever the current opportunities unfolding become more profound.”
Hatfield has been a partner at Clifford Chance since 2002. At the firm, he specialises in private investment funds, advising on the structuring and marketing of such funds as well as commercial issues arising from the operation of such funds.
Hatfield began his legal career with Clifford Chance in 1991 and qualified in 1993. He was named as one of the private equity real estate industry’s leading fund lawyers in Chambers’ 2010 UK Guide to the Legal Profession.
RREEF Real Estate
Papachristophorou is a managing director of RREEF Real Estate and global head of opportunistic investing, which comprises a series of high-yield products. Prior to that, he was the co-chief executive officer for Europe, the Middle East and North Africa and has been instrumental in integrating and consolidating RREEF’s alternatives platform in Europe.
Since joining RREEF, Papachristophorou has completed and/or restructured more than 60 investments with a gross asset value in excess of €20 billion. He joined Deutsche Bank (Bankers Trust at the time) in March 1998.
Hodes Weill & Associates
Field just joined Hodes Weill & Associates as a partner in January. In his new role, he is responsible for managing the business activities of the firm in Europe, including coverage of institutional investors and investment and fund managers.
Previously, Field sat on the international board of Grosvenor Fund Management, with responsibility for business development and capital-raising across all regions. From 2003 to 2009, he was a director at Credit Suisse in the firm’s real estate private fund group, where he was responsible for developing the European business and raising capital from European institutional investors for various private equity funds globally.
Senior vice president
Metropolitan Real Estate Equity Management
Ford is a senior vice president at Metropolitan Real Estate Equity Management, where he is responsible for identifying and evaluating primary and secondary investment opportunities in Europe and the United Kingdom. In addition, he is a frequent guest lecturer at Georgetown University’s McDonough School of Business.
Prior to joining Metropolitan Real Estate, Ford was a management consultant with Simon-Kucher & Partners, where he specialized in pricing and marketing strategies across a broad range of industries in Europe, Latin America and the US.