EUROZONE: Cash boxes

Europe is seeing the rise of the listed property sector. On February 28, Los Angeles-based Kennedy Wilson tapped the markets for a $1.7 billion initial public offering of Kennedy Wilson Europe Real Estate on the London Stock Exchange. In a second example, Hispania Activos Inmobiliarios raised €500 million on the Madrid Stock Exchange last month. Also in Spain, there are Lar Espana Real Estate Socimi, which announced its plans on February 12 for an IPO to raise €400 million, and Magic Real Estate, which is the latest company said to be lining up a listed vehicle.

Arguably, the recent trend of launching listed property companies began in Ireland at the end of 2013, with the success of Green REIT and Hibernia REIT. Whatever the provenance, these vehicles have piqued the interest of private equity real estate professionals for a number of reasons. For one thing, they are mainly being managed by people involved in opportunistic real estate investing, prompting curiosity about comparative fee structures. Private equity firms also are wondering to what extent the listed sector is a threat in terms of attracting institutional capital that typically goes into private funds. In other words, are these public vehicles ‘disintermediating’ private equity and are the managers getting paid better?

On the matter of investor attrition, there is an issue but not a life-threatening one. Taking Hispania as a working case study, it attracted Dutch administrator APG Asset Management – an important investor in private funds – as one of its cornerstone investors, so that indicates some overlap. Casting an eye over the cornerstone investors of that company and other new listed groups, it is clear there is a mixture of short-term hedge funds and long-term money managers taking part, so it is notable to that extent.

However, while there certainly is some overlap in terms of investor bases with private equity, the world is a big place and there is so much money coming into Europe that a few billion euros raised by the new wave of listed companies won’t be a game changer. This is especially true when one considers there is an estimated €60 billion of institutional money that Colliers International says is seeking a home in European real estate. The listed sector, therefore, is unlikely to disintermediate private equity funds, though it is a cause for some concern.
As for the second issue of fee structure, it is a mixed picture. Kennedy Wilson’s listed vehicle charges a performance fee paid in shares based on share price performance. This looks traditional.

On the other hand, Hispania seems to be borrowing more from private equity. It charges a performance fee element that only kicks in when it sells its investments, just like in a private equity fund. Investors get their money back first, and the manager gets a promote if a 10 percent per annum hurdle is reached. So the earn out is ‘back-ended’, as the jargon goes, and therefore only earned after a real return for investors.

This gets around the potential problem of listed funds, where the promote usually is paid on a valuation or share price basis, sometimes annually. That has meant that, in the past, managers of listed vehicles could get rewarded even if investments ultimately underperformed.

Indeed, Hispania presents a very interesting case study and, quite possibly, is unique. While borrowing from private equity, the listed vehicle also exhibits flexibility that private equity fund don’t have (sometimes on purpose). It is designed to last for six years only – three years investing and three years divesting (which tells you something about the pressure the team will be under to buy quickly and well).

Of course, fee structures in opportunity funds have been criticized for being overly generous to the fund sponsor and encouraging risk and leverage. Plus, investors get locked up in the structure for 10 years and the structure is not flexible.

Hispania, however, has the option to turn the vehicle into a permanent company if shareholders vote for that after three years. It may be that an office portfolio built by Hispania could be spun off and listed, or maybe the company will decide to keep the combination of assets together and convert into Socimi – Spain’s equivalent of a REIT – in order to ultimately get the benefit of the tax efficient structure. If things don’t go that well and the share price trades at a discount to net asset value, it can be liquidated and the money returned to shareholders. Apparently, investors have appreciated this optionality, at least according to Hispania.

Interestingly, unlike other listed real estate companies seen in Europe, there is no potential conflict of interests because Azora, the external manager of Hispania, has fully invested its private funds (with the exception of a student housing fund created last year, which is why student digs are excluded from the Hispania’s target property types). Staff can fully concentrate on Hispania, barring the student accommo-dation, thus eliminating the conflict issue.

Obviously, these are early days in Europe’s new listed property wave, and it only will be possible to tell if they are successful in a few years’ time. Maybe it is just fashionable to list a vehicle in Europe and, like all fashion, it soon will go out of style. Given the amount of capital around, private equity shouldn’t feel too threatened or jealous.