With an economy increasingly poised for recovery and one that represents more than a third of the invested global property universe, European real estate is attracting significant interest from both domestic and international investors.
The beginning of the rent growth cycle at a time when European Central Bank quantitative easing (QE) has pushed European government bond yields to record lows provides a compelling cyclical opportunity, as evidenced by the historically wide spread between the Eurozone All-Property prime yield and 10 year German Bund. Favorable relative value combined with recovering real estate fundamentals and reduced investor risk aversion should translate into property price appreciation over the next few years.
A dearth of development starts in the post-gfc era now in the seventh year means that the supply of core modern accommodation is increasingly in short supply and rent growth expectations are rising. That is especially the case for the better quality core stock. Accelerating growth means core commercial real estate yields are likely to continue on a downward path as the recovery gains traction.
With capital markets pre-occupied with the timing and pace of US rate hikes, Europe’s QE program is currently set to continue building until at least September 2016. The resultant effect is a Euro/Dollar exchange rate now approaching parity, following a weakening of circa 25 to 30 percent over the last 6 months or so. That offers an enhanced market entry for US Dollar denominated commercial real estate investors who are generally prepared to remain unhedged.
The simplest way for investors to gain cost effective exposure to core real estate with meaningful diversification is via core open-end (pooled, unlisted) funds that invest in diversified portfolios of high quality, income producing, well tenanted and well located properties across all key segments of the market and with modest financial leverage and little, (re)development risk. Such funds are well entrenched in the US market – a single country – but investor options to access this type of strategy across the complex, diverse and heterogeneous real estate markets that comprise Western Europe are more limited.
In the US there is a mature, deep and liquid market for core investment product in fund format. The National Council of Real Estate Investment Fiduciaries (NCREIF) Funds Index – Open Ended Diversified Core Equity (ODCE) provides historical returns back to 1978 and today comprises 23 open ended commingled funds managed by a range of US based managers, with a GAV of $173.1 billion and a NAV of $133.3 billion (as of Q1 2015). Sizes of individual funds range from about $300 million up to $25 billion. To that extent, investors seeking core returns in the US have a range of options available to them. Particular characteristics, mechanics and styles of each fund will differ, enabling consultants and investors to match their expectations and aspirations.
In Europe the contrast is stark. The total INREV universe of private funds in Europe has a market cap of circa €275 billion. Of that market cap, around €80 billion comprises core open ended balanced funds, but the vast majority of those core open ended balanced funds comprise the German open ended funds universe – amounting to circa €73 billion. If we strip out the German open ended funds universe, we are left with sub €8 billion of assets which comprises the universe of core pan European balanced funds available to investors outside of Germany. That’s around 2.5 percent of the INREV universe.
The majority of the dozen or so funds that comprise this universe were launched in the early 2000’s up to 2007 and, to that extent, a number of them suffer from legacy issues. In particular, there have been only a couple of fund launches since the 2008 vintage and both these funds have seen significant inflows from investors from Europe, US as well as Asia. It is clear that significant queues have resulted with investors having to wait for extended periods of time before their money is invested.
There is therefore a clear requirement from consultants and investors alike for more core pan European open ended balanced funds and, to that extent, for those managers that have the necessary infrastructure in place and the desire to establish appropriate funds in Europe, the opportunities should be significant.