Yields of under 4 percent and under 3.5 percent are expected for office and retail real estate respectively, says Marcus Cieleback, group head of research at Hamburg-based real estate investment company Patrizia Immobilien. He puts this down in part to the European Central Bank’s (ECB) plan to acquire government bonds which he says will drive the price level of commercial real estate up as well as increasing demand, which in turn will cause these record low yields.
Cieleback is not alone in expecting pricing of core European real estate to skyrocket and for returns to be diminished. In fact, fund managers speaking to PERE at real estate conference MIPIM (see pages 27 onwards for detailed coverage) say they have been in conversation with investors regarding the return expectations of their core offerings due to the market’s hot pricing. AEW Europe’s chief executive officer Rob Wilkinson for instance, says that the vast amount of capital allocated to real estate would cause return expectations to decline for the most core strategies, but not for more value added or opportunistic strategies.
It is easy to see why pricing is on such a rise as, besides the ECB’s intervention, demand for real estate increases due to the volatility of equities and bonds offering very little yield. The vast amounts of capital looking for a home in core real estate far outstrips the available stock. In fact, a recent CBRE survey of 280 real estate investors says that access to competitively priced stock is the biggest problem today. Nearly all – some 91 percent – of investors cited one of ‘availability of assets’, ‘asset pricing’ or ‘competition from other investors’ as the biggest obstacle to investing.
It is no wonder then that Patrizia’s Cieleback says that real estate investors need to move up the risk spectrum to get decent returns. He says the recent trend of rising rents and vacancy stagnation for office real estate in Europe will continue and that investment strategies must now be reviewed and more heavily oriented towards value added-style risks and returns. Yet, he adds that such an outflow of capital from core real estate in both the office and retail segments is not to be expected.
Of course some will certainly be adjusting their strategies to avoid the low return environment of European core, says the CBRE survey. The survey says the attractiveness of value add and opportunistic real estate among investors has risen 10 percent since last year and investors are constantly having to evolve their investment strategies.
The danger of this of course is that when a fund manager moves up the risk spectrum in order to meet investors’ expected returns it may be to a level which the investor has not agreed to, or will mean a divergence from the planned investment strategy.
Some fund managers tell PERE they expect to see bad decisions made as they will not want to be honest with their investors in explaining why they should expect lower returns, or simply because they are too impatient to wait for the right core asset to become available.
That’s not to say that all opportunities to make good returns in Europe are gone; but, rather that the low hanging fruit has already been plucked. Take for instance the move towards ‘alternatives’. Described by one pan-European fund manager as the emerging sector in Europe alternatives was high on real estate investors list of key themes for 2015. In fact, the CBRE survey says investors will be actively be pursuing opportunities in student accommodation (27 percent), leisure/entertainment and healthcare (both 17 percent) and retirement living (15 percent). The trend is already bearing out too, just last month the Canada Pension Plan Investment Board (CPPIB) entered the UK student housing market when it acquired a 100 percent stake in Liberty Living, for £1.1 billion (€1.52 billion; $1.67billion). Earlier this year LaSalle too made an £81 million UK student housing play.
But, for those looking at moving into alternatives the fund manager has a word of warning: it is a private equity deal so knowledge of the operating model is imperative.