The rain continued to fall on London as participants gathered for PERE’s European roundtable at the end of February. Across the Continent, however, the climate for real estate investment is looking sunnier by the day. 
Indeed, investor appetite is back, not just for core property but also in markets that were no-go zones just one year ago. Much of that capital is coming from outside Europe and is seeking higher returns by taking on complex deals, alternative property types and a greater level of risk.
Those were the conclusions of the roundtable’s three participants: Gordon Black, who leads European operations at Heitman; Jonathan Harris, head of advisory for the EMEA region at Macquarie Capital; and Jonathan Hull, who leads property services firm CBRE’s capital markets team in Europe.
In fact, CBRE’s latest figures attest to the depth of Europe’s recovery. In 2013, the volume of commercial real estate traded in Europe increased by 30 percent on the previous year. The figures for the fourth quarter of last year are even more telling: the nearly €61 billion total was the highest quarterly figure recorded in Europe since the fourth quarter of 2007, when the market was teetering on the brink of the global financial crisis.
A recovery at last  
Up until the middle of last year, foreign capital coming into Europe focused primarily on prime London property. “Coming back from the summer holiday last year, there was no further crisis to talk about,” Hull observes. “In the previous five years, we either had a currency hiccup or a default in Greece. Every time we came back from the summer, there was something to worry about. This time was the first time the stars were aligned and everyone became a little less cautious.”
Black, who has been working in Europe for almost 20 years, agrees that the change in the macroeconomic situation has had a profound effect. “Back in July and August of 2012, no one was sure whether the Eurozone was going to stay together,” he says. “That break-up possibility is now off the table.”
That confidence grew throughout the latter half of 2013. “The market had its busiest final quarter in many years, both in London and in Germany – and other markets as well,” says Hull. “I think we probably have had a busier January in terms of developing stock and ideas for clients this year than we have had for many years.” 
As the economic recovery takes hold, the feeling in Europe is that there will be increasing pressure on central banks to raise interest rates. The question is whether a shrinking gap between borrowing costs and yields will affect the attractiveness of prime real estate.
Black is unconcerned. “Real estate is always going to ride between fixed income and equity, which is where it should be,” he says. However, he quickly adds that capitalization rates have not moved down with the central bank’s interest rates and monetary policy, so there is a built-in ‘cushion’ between property prices and interest rates today. Additionally, the EU is likely to trail the UK in raising rates anyway. “We don’t think there is going to be a big impact in the near term,” he predicts.
Harris believes that, although interest rates will rise, property owners will be able to reap the benefits of economic growth. “In the medium to long term, we will see a higher interest rate environment for good economic reasons, which should be accompanied by higher rents and ultimately higher values,” he says.
Furthermore, future growth will be delivered by an increase in occupier activity rather than capital values. “Given where we are with yields in most markets, we are not going to be seeing yield compression,” argues Hull. “People are forecasting growth – or not – for individual markets based on occupational demand. It will be the different business environments and employment numbers that will be the drivers of change.”
Moving up the risk curve 
The shift in sentiment means that, after six years of lean times, money is now pouring back into the market and driving demand for riskier investments. Harris notes that there has been an abundance of equity capital and an easing of credit generally, whether it is the capital markets or banks. He adds that this oversupply of capital has been focused on a relatively narrow subset of opportunities – primarily core and gateway – for the last few years. 
“What has been happening for quite some time and is now gathering pace is that [capital] has been moving up the risk spectrum and away from the really obvious places,” Harris says. “It has been seeking complexity in an effort to find deals that you can do without 40 other people competing against you or where you can find value.”
Banks have eased lending conditions, and alternative providers of leverage such as private debt funds have further boosted the supply of credit. Black argues that there is now no ‘debt gap’ except in the riskiest and most peripheral areas of the European market.
“We have broken down the numbers for last year on where equity and debt sits, and there is now more equity in the market than there was at the peak of 2007,” chimes Hull. “Most of the equity still comes from the US, but we have seen a doubling of capital from Asia from 2012 to 2013.” Indeed, foreign capital accounted for 44 percent of the total volume of European real estate transactions last year.
“In the last two years, so much equity has come to London and the UK market from all over the world,” Hull continues. “The equity base is now more diverse than it has ever been – from the US, Canada, Japan, Taiwan, Hong Kong and China. What is quite interesting today is a lot of the equity that has been to London is now looking at the Continent. Even in markets like Spain, which not even a year ago was finding life very tough, the bidding pools are really strong not just for core but for value-added investments as well. Furthermore, we are seeing opportunistic investors bidding alongside core and core-plus funds.”
Black says it is North American and Asian capital that is taking the lead, while many European institutional investors with large real estate portfolios remain conservative in their outlook and focused primarily on core property.
Fundraising eases 
What of the environment for those seeking to raise capital? It seems fund managers have embarked on a round of equity launches seeking to take advantage of the opportunities presented by the recovery. The Blackstone Group alone has raised €4 billion for Europe, begging the question whether there is enough equity to satisfy the opportunity. 
“I think there is,” responds Harris. “It is a much more supportive environment for good management teams, good assets and good investment theses. I think investors inevitably will become marginally less selective, although the market won’t move quickly to where we were seven or eight years ago, where almost any team could spin out and raise capital.” 
“We are far away from that,” affirms Black, adding that investors will continue to select their managers carefully. “Two years ago, there were very few funds that were raised. Now, there is interest because the North American and Asian groups, realizing that Europe is not going to break up, are willing to go up the [risk] curve. Most of the teams fortunate enough to raise money as of late have been oversubscribed.” 
Harris predicts that investors will want to maintain close supervision over how managers spend their money. “What remains very difficult is raising discretionary money without a super-solid track record and a lot of time in the market,” he says. “With respect to smaller, more geographically constrained teams, you will see money flow to those opportunities as well from some investors, but they will be semi-discretionary in nature and with different governance structures.”
Indeed, the desire for control has driven a number of investors toward separate account or club deals and may prevent some from entering commingled fund structures, explains Black. It certainly has been one of the factors behind the increasing prevalence of club deals backed by a small number of investors. 
Still, the popularity of clubs may have waned a bit recently, given the model’s structural complexity. “They are still out there, but what we tend to find is there are lots of single-investor joint ventures and two-investor clubs,” says Harris. “Investors who have re-embraced clubs have figured out who they want to be in clubs with, and they are very picky.”
“A year or two ago, a club was the only way to get to the kind of volume that you needed,” observes Hull. “Today, there is such a depth of equity in the marketplace that a club is quite a complicated buyer or seller to deal with. People like simple solutions.”
Meanwhile, the sheer size of some of the commingled funds that are being raised may limit the range of opportunities that they can consider, Black argues. “If you have raised more than €1 billion and you put leverage on that, you are talking about at least €3 billion of spending power,” he says. “You are never going to do a deal less than €150 million. It would be very hard for you to rationalize it.”
For that reason, Heitman typically looks to raise funds of around €500 million, allowing the firm to do deals of €70 million to €140 million in size. Black contends that such a mid-market strategy provides better access to deal flow where there is sponsor- or bank-driven dislocation.  “We think there will be significant opportunities in this slice of the market, with the best risk-adjusted returns for our clients,” he says.
Going south 
Despite its mid-market dislocation strategy, Heitman will not be diving headfirst into some of the markets that suffered the most during the recession. “You don’t have to go that far outside of core to find dislocation, so we are not focused on Spain and Italy,” says Black. “That is not to say anything negative about those markets, but we are focusing our resources on opportunities in Central Europe, the UK, Germany and France. In the core of Europe, there is still plenty of dislocation.”
Black continues: “Last year, we were concerned whether Spain would be in the euro.  In the event of their departure, there was no recovery on a currency play that would save us. Therefore, the market has been a little off of our radar. Looking at Italy, pricing has never moved out as that market is very insular in terms of how it works.” Still, he admits that some opportunity funds have done deals in those countries that “look really good from the outside.”
Hull believes that increased investor interest in southern Europe is an indication of how far the recovery has progressed. “The fact that there is a price is why Spain is now back on the radar and sales are now coming to the market,” he says. “When you go back into the depths of the recession, it was very difficult to price anything.”
Harris, however, argues that taking on nonperforming loans is best left to the experts. “It is a very specialized form of real estate investment, and there are a handful of players globally that know what they are doing and are resourced to do it,” he explains. “Even the people who are expert at that form of investment have called some markets wrong, but there has been a lot of money made as well.”
An uneven recovery 
The recovery is far from being evenly spread across the Continent. While some markets like the UK and Germany are demonstrating clear signs of a return to health, others are lagging far behind. “We own assets all the way down into Bulgaria,” says Black. “That is a market that there is no recovery for right now. If you went to the Czech Republic last year, there were virtually no transactions.”
Still, things are starting to change, even outside the core western European markets. “We have seen generally positive growth indicators – not everywhere, but we have seen purchasing managers’ indices looking strong for the last 15 months throughout Central Europe,” says Black. “Tenants that were frozen are starting to make decisions and taking longer-term leases, so there are all the classic signs of market recovery. While it has taken time for the markets to show signs of recovery, we can start to look at this as a positive story.”
Hull adds that Poland can now be considered a core market in terms of its style and investment trends, while Harris says changes in the European economy underpin the status of Central European markets. “Poland, the Czech Republic, Slovakia and Hungary are the workshops of Europe,” he argues. “There has been a structural shift in jobs and supply chain to these places over a long period of time now.”
Heitman, for example, purchased some of central Budapest’s best office properties during the downturn. Black says the buildings fell out of favor because the former owners were seeking unrealistic rents. However, when the market recovers, Heitman will be sitting on high-quality real estate that it bought for a very attractive price.
Many investors, however, find such purchases difficult to justify. “Generally, people struggle when they try to underwrite something that is structurally over-rented,” says Harris. “That is when a lot of capital goes home straight away because people are used to underwriting upward-sloping graphs.”
The rise of alternatives 
Both Harris and Black strongly favor investments in alter-native property types such as self-storage, residential, student housing, care homes, medical offices and data centers. Harris describes such assets as “proxies for core or core-plus,” where greater returns compensate for greater risks with the bonus that there are fewer competing investors in the market because of the assets’ greater complexity.
“You can often find distressed, under-capitalized and under-managed assets, or a platform that is under-exploited,” says Harris. “If you get a bunch of those things together, that is a really attractive situation. Student housing in the UK is a classic case in point. We have been active in it for the last few years. You can get very well rewarded for the underlying risk.”
Black adds: “When it comes to alternatives, the drivers for demand are totally different. In some cases, they are needs-based, and that is why we view them as de-linked from the broader economy, but you need to pick your operator very carefully.” He observes that big institutional investors like GIC Private Limited and the California Public Employees Retirement System recently have begun to invest in alternative property types in Europe.
“You have the US REITs and big institutional players coming into those markets and opening them up to a broader spectrum,” confirms Hull. “The fastest growing sector this year into next year probably will be residential. There is the truly institutional multifamily-style investment, but you also have global capital looking at residential as a very safe, secure place to be, which is where London has performed very well.”
Compared with the US, where multifamily housing is a major property type, residential property as an institutional investment is in its infancy in most European markets outside Germany. “It is something we have been trying to figure out a way to unlock,” Black says. “In the UK, ownership is fragmented so it is hard to get scale, but I think it is coming.”
In January 2013, Macquarie agreed to provide £40 million of debt funding to Thames Valley Housing Association’s private rental subsidiary Fizzy Living. Harris believes that creating substantial rented residential assets will involve big brownfield regeneration schemes in London, which means central and local governments will have a major role to play in ensuring the sector’s success.
Future prospects 
What will be the trends that will define the European real estate market over the coming months? “There is certainly a greater risk appetite, and that is manifesting itself in a lot of capital chasing refurbishment and development,” says Harris. “It won’t just be in [London’s central district of] Victoria, it will be in Manchester and Birmingham as well, and residential in regeneration areas that are well connected to transport.”
Heitman will be developing, although only in the alternative property sectors. “A lot of the stock needs to be purpose built,” says Black. “A good example is senior housing in the UK. It is at a place where the market is shifting to premium private paid care homes.” Heitman also will be looking to build up its logistics portfolio across Europe.
Harris returns to his earlier theme of investors seeking complexity and predicts more investors will seek to secure property through corporate acquisitions. “We tend to get involved in them because we are a mixture of property, capital raising and corporate finance,” he says. “We are always curious whether we might find value there, but we are seeing people embracing complexity almost for its own sake and perhaps not quite having the experience to discern where it is a fool’s errand.” 
There is no doubt that the recovery in Europe is well underway. With capital pouring in to take advantage of the rising tide, how and where that money is put to work will be the difference between success and failure. 
“When we look back on 2014, it will have been a very interesting year for new equity coming into the continental markets, not just into the core space but into development as well,” Hull predicts. As always, however, it will be those investors and fund managers ahead of the pack in terms of strategy and expertise that will benefit most.  
Gordon Black 
Senior managing director 
Black is co-head of Heitman’s European private real estate equity group and an equity owner of the Chicago-based real estate investment firm. Since 1995, he has been responsible for the firm’s investment activities in Europe and has been involved in global acquisition and disposition activity totaling just under €8 billion.  
Jonathan Harris 
Senior managing director and head of real estate for EMEA 
Macquarie Capital
Based in London, Harris leads the European arm of a global real estate advisory team that has raised $40 billion in equity commitments for a range of real estate transactions and funds since 2003. Having joined Macquarie Capital in 1996, he has led mergers and acquisitions, restructurings and capital raising assignments valued at more than £14 billion across public and private markets in Europe and Australia.   
Jonathan Hull 
Managing director of EMEA capital markets
CBRE Capital Markets
Hull is the managing director of CBRE’s EMEA capital markets team and is a member of the property services firm’s global management team for capital markets. He is responsible for coordinating the group’s activities in Europe, specializing in advising clients on the disposition and acquisition of real estate assets and portfolios across the region. In the past year, he has been engaged in the sale and purchase of some of Europe’s most important properties, including a prime office tower that traded for more than €500 million.