EUROZONE: The composition conundrum

Over the past few months, PERE, and this column in particular, has been busy tracking the vast sums of money that have been bent on gaining access to European real estate.

Back in May, global real estate services firm DTZ said that €125 billion of new capital was targeting European commercial real estate, which was putting the region on track to beat its previous annual peak investment volume of €230 billion.

Europe’s macroeconomic climate, among other factors, has continued to make real estate in the continent a very attractive proposition. The falling Euro compared to a relatively strong dollar, for example, only helps to boost the region’s appeal.

Such is the pent-up demand from certain buyers for European market share that they are, in fact, willing to pay a premium for large portfolios that can offer such share in one fell swoop. The long-held principle of buying property wholesale and selling retail is being turned on its head.

Looking at the Nordics, for instance, Nordic Real Estate Partners (NREP), a Denmark-based private equity real estate fund manager, struck the largest-ever portfolio sale of prime logistics properties in the region, and the largest exit in the firm’s 10-year history, in May.

In the transaction, the firm sold all the underlying assets in its NREP Logistics Fund and three properties from its C1 Fund for approximately €650 million. And although the buyer was a consortium of four Danish pension funds, bidders came from a wide variety of capital sources, including sovereign wealth funds and even opportunistic funds.

Los Angeles-based Ares Management too has been scaling up its European real estate holdings via portfolio acquisitions this summer. The firm reached an agreement to acquire a 2.58 million square foot pan-European office portfolio from IVG Institutional Funds. The portfolio of 30 properties located across six European countries, including the UK, France, the Netherlands, Belgium, Finland and Spain, has been valued at more than €400 million.

But, the buy-side should stay mindful of another long-proven tenet when it comes to portfolio assembly: that portfolios include more chaff – assets that require heavy management and capital expenditure – alongside the wheat than they should. The temptation for managers to use current demand to offload problem properties is surely there.

According to one real estate fund manager, such a scenario is indeed happening and causing some large portfolio sales to fail as big-team asset managers are more likely detect a ruse.

The manager said that some portfolios he has seen haven’t met buyers’ quality criteria. He added that although it is tempting to view such portfolios as cheap compared to single assets, or as an opportunity to put significant capital to work in one go, fundamentally, if the real estate is not good, it won’t sell. This is a considerably different attitude to the last market zenith, when portfolios would have been bought almost without question.

Moreover, portfolio sales can fall through for reasons aside from bad assets being mixed in with the good. Sometimes the composition of asset types, location and risk can limit the ultimate universe of available buyers.

For example, the San Francisco-based industrial real estate developer Prologis was said to be a firm that didn’t get its composition right when looking to offload a roughly €650 million European logistics portfolio earlier this year. The company’s Stellar portfolio consisted of logistics assets in UK, Germany, France, Poland, Italy, and the Netherlands.

But, according to one potential buyer of the portfolio, Prologis struggled to garner serious attention as some territories and countries, namely Poland and Italy, were off limits to certain investors. The portfolio’s size also disqualified large chunks of the market too.

It is understood that Prologis then decided to re-position the portfolio and break it down country-by-country, and now portfolios such as Dragon – Stellar’s German assets which are valued at around €130 million – are out in the market.

The message for sellers is clear: take greater care of arranging portfolios sales, as the market is still discerning about what it considers good value. For buyers, don’t rush into buying portfolios that will have you inheriting asset management headaches from properties that don’t match your firm’s skillsets.