EUROPE ROUNDTABLE: Come for core, stay for opportunistic

Goodwin Procter
Morgan Stanley Real Estate Investing

The Townsend Group

Situated in the shadow of St Paul’s Cathedral in central London, one likely couldn’t get a more touristy location for this year’s European roundtable. Perhaps that is fitting, as the four roundtable participants drove the discussion around the theme of international capital ‘visiting’ European cities such as London in search of core real estate.

Taking part in the roundtable at CBRE’s City of London offices were Mark Evans, who heads up the equity placement business at the global property services firm; Nick Cooper, a principal at real estate consultant The Townsend Group; David Evans, the London office chair of US law firm Goodwin Procter; and Brian Niles, who is responsible for running Morgan Stanley’s real estate investment business across the entire European region.

To discuss the European marketplace from an opportunistic angle certainly requires acknowledgement of the huge demand for core assets that exists among global investors, and London nowadays is symbolic of how world capitals have become magnets for them. Yields in London have reduced noticeably, and the city remains one of the top places – if not, the top destination – in Europe for international investors, whether they are Asian sovereign wealth funds, Canadian pension plans or something else. 

There seems to be no sign of that abating either. Indeed, just recently, CBRE produced an investment ‘intentions’ survey suggesting that, in keeping with the established trend, 53 percent of some 362 real estate investing organisations still feel prime/core property in Europe is the most attractive asset – a higher proportion than in 2012. 

Origins of the capital

First up is Cooper, who just returned to London after a two-year stint in Cleveland, Ohio, where Townsend is based. Given he has been surrounded by US investors for the past 24 months, he was as good a place as any to start. 

“The world moves in cycles,” Cooper says. “In the US, they feel they have had a good run in terms of recovery, and I think they now need to look towards Europe as their next recovery point and to see whether there are some rich pickings to be had.”

Cooper believes there are a number of US investors that selectively will “pick up” investment opportunity in the UK and Continental Europe, and that they will do so over the course of the next 12 to 24 months. Indeed, many of the big US public pension plans have capital to deploy, and most probably are below their strategic real estate weighting, he notes. 

“Those groups certainly will look,” Cooper says. “Capital is in global flight and will look for opportunities in markets it finds attractive.” Of course, he is speaking not just of American institutional investors but of a global cast of investors that want exposure to physical assets.

CBRE’s Evans immediately picks up the theme, as his unit’s equity placement function is essentially to marry up global sources of capital with “best-in-class” real estate operators and managers. The team, which consists of six people in London and two more in Amsterdam, links up to equivalent CBRE professionals in the US and Asia Pacific. Given that perspective, he agrees with Cooper’s last statement on international investors looking towards Europe, adding that the group likely will include Australian funds.

“Over the next 12 months, I think we are going to see the Australian superannuation funds enter the market. That is because they can’t find the right opportunities in their domestic market,” says Evans. “I think they will come to invest in core product with best-in-class managers and low levels of leverage. Clearly, the pension regulations are changing down there, and more money is going into them, forcing them to go into other regions.” 

Are there any other sources of capital to watch and where will they go? The answer as far as Evans is concerned is the Far East. “If you look at the Far East, I think that is one of the key markets where we are going to see capital moving over the next 10 years. Just look at the sheer weight of money in that region, as well as the population profile. Again, they are looking to come to the most liquid markets in Europe such as London, Paris and Germany, where wealth preservation characteristics are present.”

Looking beyond core

Like CBRE’s Evans and Townsend’s Cooper, Goodwin Procter’s Evans has witnessed the weight of capital chasing core prime property. Still, there are some interesting pockets opening up. “We are beginning to see US capital start to look at Europe, but more in the value-added space as opposed to core,” he says. “The other area you are seeing interest in is Ireland, particularly in private equity.”

The reference to Ireland immediately prompts Niles to explain what Morgan Stanley Real Estate Investing (MSREI) is seeing. After all, the firm’s Morgan Stanley Real Estate Fund VII Global fund recently acquired a €220 million portfolio of nonperforming loans from Ireland’s National Asset Management Agency (NAMA).

While MSREI has observed many transactions conducted by those chasing core assets, Niles says he also sees capital from Asia looking for opportunistic returns and seems skeptical about North American investors wanting to buy core in Europe. 

“I think the North American investor base is less interested in investing in European core for two reasons: their focus on total returns and the exchange rate risk,” Niles explains. “Their view is ‘If I can already access this return profile in the US, why would I want to buy something with a 5 percent yield and take additional risk with the exchange rate?’”

Niles develops the theme: “There are definitely a large number of investors out there that still view European assets as predominantly distressed.  Some of them have been frustrated by the lack of deal activity because it results in a lot of capital chasing relatively few opportunities.  However, when things have been organized on the sell side, we actually have seen some pretty good pricing from the seller’s perspective, even with distressed assets.”

Niles continues: “Looking at Europe as a whole, we think there is a major deleveraging process that needs to happen. Unlike in the US, Europe doesn’t really have a deep and functioning capital market, so this is going to take some time to play out.” 

The contrast is clear. Niles points out that, when the global financial crisis hit in 2008, the North American banks acted promptly to shed their loan exposure to European real estate and “moved on,” but that hasn’t been the case among European banks. 

In the UK, Lloyds Banking Group and Royal Bank of Scotland have been notable examples of the few banks that have acted. In Ireland, NAMA also is transacting after a slow start, though the assets in the case of the portfolio that MSREI acquired actually are located in the UK, not in Ireland. 

“When you look at the European banks, to date very few have started moving their positions in a meaningful way,” emphasizes Niles.

Picking up the pace

Crucially, MSREI is seeing the pace of activity finally starting to pick up. This is one of the biggest themes in European private equity real estate at the moment – to what extent are distressed opportunities coming to market? In recent weeks, various studies and pronouncements have been made ranging from predictions of a glut of large-scale nonperforming loan portfolios to slow, deliberate and incremental dispositions of smaller lot sizes. 

While MSREI is taking the view that there is not going to be a sudden wave of distressed assets, Niles nevertheless still sees opportunities increasing significantly. “To some extent, the market is coming to us,” he says. “We have been very cautious because Europe has been going sideways from a macroeconomic standpoint since 2010. We have underwritten everything thus far with the assumption that there will be no growth, but we do see a lot of opportunities in Europe and we think we will continue to see them for the next several years. It is going to be a good environment to be operating in. We see the pace of activity finally starting to increase, but we don’t think it’s ever going to become a flood, simply because that’s not how counterparties are going to behave.  What we’ve consistently been saying to our investors is that this process in Europe is a long game.”

A lot of this is resonating with Goodwin Procter’s Evans. A key rationale behind the law firm scaling up its operations in London is tied to what its US client base is doing in Europe. Back in the States, where has been operating for more than 100 years, Goodwin Procter has built up a large practice specializing in private equity real estate with a roster of around 80 or so fund managers, including household names such as Brookfield Asset Management. One only needs to witness what the firm is doing in Europe to understand why Goodwin Procter hired Evans. 

Indeed, Brookfield is trying to build up its opportunistic business in Europe and hired David Brush, the former chairman of global opportunistic investing at RREEF Real Estate, to add firepower to its aspirations to buy into distressed or complex corporate situations. Meanwhile, another US client with a European arm has become successful in Europe’s burgeoning mezzanine real estate debt fund space. 

“Fourteen months ago, we moved into another phase here in Europe and now have built a law firm largely focused on private equity real estate, from fund formation and tax advice to transactions,” says Goodwin Procter’s Evans. “Many of our US clients fundamentally are looking for distress. As those opportunities start to recede in the US, they are starting to look elsewhere. For sure, there is a fair amount we are doing in the UK and Europe, and that is going to increase because of the run off in US distress and more certainly and comfort around the absence of any break-up in the Eurozone as time goes on.”

Goodwin Procter’s European practice is busy structuring debt products for loan origination, where Evans says there is the beginnings of serious activity. “A lot of people are talking about that via a commingled fund. However, while folks may have aspirations to do it that way, the reality often tends to come back to joint ventures or clubs because the ability to raise capital is still challenging here, even into a hot market like debt,” he points out. In terms of direct equity deals, the market is still seeing JV and club transactions, particularly from US players looking to do opportunistic-type deals for development projects with local partners, he notes.

Structural weakness

Evans’ comment sparks lively debate about the model that investors are using to access real estate in Europe. “There is a perceived desire to get a little more control, but the resources to deal with that control are simply not there in many cases,” says Cooper. “The net result is that the commingled fund is not off the table. We have just underwritten a fund here in the UK that will attract $100 million to $200 million of capital from our client base, and that fund format was accepted.”

Cooper explains how there is plenty of discussion about the creation and function of advisory committees. Aside from that, a big requirement by investors is that a fund manager needs to have a very clear strategy and that, if a manager wishes to deviate from that, it will cause a ‘discussion’.

Although there is a place for pan-European opportunistic funds, Cooper says some clients of Townsend do prefer to build more specific portfolios. Fund sizes definitely are smaller because fundraising and deployment is tough, and “people don’t like the long J curve,” he notes. “That can be pretty horrible, and they say, ‘Well, I can forecast returns over five years, but 10-plus years?’ One thing we certainly would like is shorter fund life cycles.” 

MSREI’s Niles is listening closely and agrees that the message from investors is that they want shorter investment periods.

From the perspective of CBRE, Evans sees the market becoming much more “segregated” in terms of how investors want to deploy capital. He sums up that the market for the commingled fund is at the smaller investor end. At the same time, he says CBRE’s equity placement team is seeing much more activity in the club and joint venture area, which is dominated by the bigger investors who want to exercise control. Indeed, there is a view that there will be an increase in segregated account mandates in Europe, which currently is just a fraction of the segregated account market in the US.

CBRE’s Evans turns the spotlight on core property again, where he believes there should be more perpetual vehicles. “Whereas the more opportunistic strategies are very much aware of the need for a closed-ended structure, [perpetual vehicles] are where the core market is headed,” he says. “A lot of investors are struggling to buy core directly, so they are starting to move towards the JV club deal.” Furthermore, the key feature for a core vehicle is that investors must have redemption rights because a firm “cannot lock investors’ capital up indefinitely,” he adds. 

Evans has an example that neatly encapsulates the themes in the discussion so far. Recently, CBRE worked with Dutch insurance company ASR, which held a first close in 2011 for a prime Dutch retail fund. It raised €380 million through a perpetual structure with a two-year lock-up and quarterly redemptions. It is unleveraged, but the manager can leverage up to 30 percent of gross asset value. However, the manager cannot leverage up, take the maximum amount out and then stop investors being able to redeem their capital, he explains. Instead, the manager has to manage down its leverage. 

“It cannot work for all strategies, but for big core strategies you can use that,” Evans says. “I believe the more closed-ended structures should be there to take account of market timing cycles like development and so on, and those should be the vehicles giving higher returns. We see investors wanting capital deployed in a very short amount of time – up to two or three years generally. In those cases, it is more difficult to raise completely blind funds as opposed to seeded vehicles.”

Cooper, however, seems unimpressed with Europe’s offerings for those seeking core properties. “The core industry needs to think very carefully as I don’t think that the current offerings fulfill the needs of the market,” he says. “In the US, you have a much larger market and you effectively get delivered a real estate market return, which is what we are after. We don’t want debt on the fund because we want our core real estate to deliver a core-like return, which our studies say does good things for our risk-adjusted returns. If this is not available, then the industry is going to surrender itself to the listed market.” 

In fact, Goodwin Procter’s Evans has been thinking the same thing. “The circumstances now are tailor-made to oxygenate REITs,” he says. In the same breath, however, he notes that it does not seem to be happening. 

Niles agrees, adding that it’s because the listed sector in Europe is an ‘after-thought’. “There should be more REITs,” he says. “Those vehicles ultimately will be created, but it is just taking a lot longer.”

No apparent rush

Something else taking a lot longer in Europe is regulatory certainly. Goodwin Procter’s Evans neatly combines a couple of big themes in European private equity real estate by mentioning Solvency II regulations and the current penchant among many investors for real estate debt. 

Towards the end of last year, guidance was issued on Solvency II seemingly suggesting a re-weighting of real estate debt in terms of its risk allocation. For insurance companies, it looks like real estate debt investments may be treated more like a bond than a ‘look-through’ to the asset and therefore may not be as attractive as first thought. 

“You have seen a number of insurance companies jump large into real estate debt as an investment allocation,” says Goodwin Procter’s Evans. “While the bigger ones might be able to write their own risk models in terms of weighting their capital, how all that will break out remains unclear to me.”

Meanwhile, talking about regulation, insurance and debt funds inspires CBRE’s Evans to opine on the successful managers in the real estate credit space. He believes the firms that ultimately will be successful are those that have two or three segregated accounts behind them. Given the diversity of Europe, he suspects there eventually will be specific vehicles for specific geographies, although he says it is not quite clear whether firms were raising debt funds on a relative or absolute return basis.

The Townsend Group already has underwritten one investment in a debt fund in Europe, highlighting demand, but that was two to three years ago. Witnessing how the offering has since expanded from senior and mezzanine debt funds to stretch senior and whole loans, Cooper believes the firm’s client base will commit to another debt strategy this year.

As well as regulatory issues, there is yet another thing taking longer. It is taking much longer than expected for investors to receive distributions back from their fund investments – a constant bone of contention between LPs and GPs in recent years. 

MSREI’s strategy for monetizing assets is interesting because it reflects a global and regional view of markets. For example, in 2009, 2010 and 2011, the firm saw strength in China but at the same time felt things were a little precarious, so it sold a number of its investments in the country. In Europe, however, it has been more challenging to make exits, but the platform has been actively selling where it continues to see strength, such as central London. 

“Over half of our attention goes to managing our current investments,” Niles says. “If the market improves in certain pockets or we complete asset management programs, then we look to monetize. Therefore, as the environment improves, we could see a fair amount of disposal activity.” 

Investment approach

At the same time as it reviews current investments, MSREI continues to invest, not least with rumours in the background of the bank raising a new global fund. So how is the firm approaching Europe? 

Niles says one focus area is ‘defensive’ types of investments from motivated sellers where the team thinks that, through asset management initiatives such as extending out lease terms, it can increase income even in a difficult economic environment. “We are looking at properties with interesting initial yields and defensive cash flow characteristics, where you can probably get some financing and good cash return on your equity,” he says. 

Then, there are distressed assets. MSREI, however, is not chasing the largest nonperforming loan (NPL) deals involving a thousand assets, which have become extremely competitive in auction scenarios. In contrast, the loan portfolio it bought from NAMA was “targeted.” The real estate investing group could identify the assets because the positions it bought consisted of just 10 loans, and most of the asset value was concentrated in four positions.

For the NAMA deal, MSREI bought the portfolio entirely with equity. “There was a very solid base in the assets but not necessarily a lot of recurring cash flow,” says Niles. “Why take leverage in that situation when we were underwriting the portfolio to 20 percent unleveraged returns. Still, you need to look at a lot of deals to find such characteristics. Is there leverage available for NPLs? Absolutely. In fact, with these NPLs, there is more liquidity and banks are more willing to lend than on cash flow-producing properties outside of central London and Paris.”

Another part of the multi-layered strategy at MSREI is about identifying high-quality core assets outside of prime locations such as central London and central Paris. That could mean Italy or Spain, where one can buy core assets at historically attractive prices. Yet another strand involves providing capital in a variety of forms as part of the deleveraging theme in Europe. That could involve complicated recapitalisations. 

Niles also mentions two huge retail acquisitions in Russia – its roughly $1.2 billion purchase of the Metropolis Shopping and Entertainment Mall, a 205,000-square-meter retail center in Moscow, and its $1.1 billion acquisition of the Galeria Mall, a one million-square-foot shopping mall in St. Petersburg. Those assets were acquired at attractive yields in a country where capital is scarce but where there is growth potential for retail property.

Perhaps it is ironic that all the participants around the table are looking for growth in their businesses while operating in a low or next-to-no growth economic bloc. Each, however, already has explained the logic of their firm’s presence. 

Cooper says The Townsend Group will look for core exposure, participate in the real estate financing market and – music to the ears – finally have a strategy for buying distress. Goodwin Procter’s business will grow alongside its clients buying core and distress, structuring commingled vehicles, joint ventures or clubs for investing in equity or in the debt. CBRE expects to continue marrying the myriad of global capital sources with best-in-class managers and operators in the region, and MSREI expects to monetize investments by prior funds and continue to make fresh investments.

Europe is a big market, and it isn’t totally clear how things will play out going forward. Still, the four real estate professionals meeting just yards away from St Paul’s Cathedral all will be working hard to build impressive businesses in the hopes of capitalizing on whatever opportunities emerge. 


Nick Cooper 
Principal and partner 
The Townsend Group 
Cooper is a principal and partner at The Townsend Group, which has oversight of client capital in excess of $110 billion invested around the world. He recently returned to London following a two-year stint at the firm’s Cleveland, Ohio headquarters and is responsible for international (ex US) business and clients. He is a former chairman of the Association of Real Estate Funds in the UK, a leading property industry group open to fund managers and others involved in the property industry.

Brian Niles
Managing director and head of Europe
Morgan Stanley Real Estate Investing 
Niles is a managing director and head of Europe at Morgan Stanley Real Estate Investing. In addition, he is a member of the firm’s global investment committee and serves as portfolio manager for the firm’s international real estate funds III to V, as well as being a director of Canary Wharf Group and Songbird Estates. Prior to joining the firm in 2006, he worked for nine years at Goldman Sachs, primarily in the firm’s Real Estate Principal Investment Area. 

David Evans
Goodwin Procter
Evans is chair of Goodwin Procter’s London office and a member of the firm’s business law department. He focuses on all aspects of real estate fund structuring and investment in many European jurisdictions and has experience dealing with complex tax and real estate issues applicable to fund structuring for both UK and pan-European funds. Prior to joining Goodwin Procter in December 2011, he was a partner at Ashurst, where he served as head of its investment funds group.

Mark Evans 
Executive director
Evans is an executive director at CBRE and heads up the firm’s equity placement team within CBRE Real Estate Finance. He advises on the structure and creation of new investment vehicles and debt and equity structuring for large complex property and corporate transactions, as well as advising on raising new equity, secondary market trading and likely fund performance. Prior to running the equity placement business, he was responsible for the capital strategies team, which undertook debt procurement, M&A advice and bespoke financial modeling in relation to complex property and financial issues. In September 1996, Evans joined Hillier Parker, which later merged with CBRE.