Europe is frequently making headlines nowadays for the wrong reasons. Uncertainty regarding the stability of the European Union in the face of a Brexit remains at the top of the worry-list when it comes to financial stability. Meanwhile, terrorist attacks in Paris and Istanbul only serve to further destabilize the region. This is not to mention ongoing tension between and within countries such as Germany over migrants and refugees.
Yet the message from the PERE European roundtable feels markedly different. Senior real estate managers frosm AEW Europe, Colony Capital, Invel and Niam assemble in London to explain how they viewed the region. And without exception, each expresses Europe in terms of an opportunity rather than a threat, albeit in different guises.
None of the participants is new to the territory. For example, Los Angeles-based Colony Capital, which operates six local offices and employs around 400 people around the world, first started operating in Europe 17 years ago. Significantly, it remains unshaken in its belief in the attractiveness of the region, especially in credit-related real estate investing.
Nadra Moussalem, head of Europe for Colony Capital, says: “We believe that the continued deleveraging of the European financial system, combined with improving labor markets and consumer spending across the continent should produce attractive risk-adjusted returns.” Indeed, Colony is witnessing a “highly attractive environment” to acquire real estate loans and assets as well as originate structured real estate debt as the traditional bank sources of finance have become disintermediated.
Evidence of this can be seen in its transactions. In the past two years, it has invested more than €2.2 billion of equity in Europe. In just one example, in December 2015, it reported the acquisition of 24 UK assets from the receiver of a defaulted 2006 CMBS securitization with €440.8 million of underlying assets.
Colony is also used to dealing with investor concerns in Europe that have surged since the economic crisis of 2008. Moussalem suggests many investors reacted with great concern about temporary macroeconomic events that should typically be evaluated in a more measured and deliberate manner. “It really has a big impact,” he says. For example, Moussalem finds discussions with some investors about the Greece situation to have been “disproportionate” in some instances.
He adds: “The media of course has a lot to do with that. Remember when you turned on a news channel at the time? It was all about demonstrations and I find it interesting the way the environment is always depicted.”
Nervousness surrounding any negative investor sentiment amid current headlines in Europe is understandable. Fears over a Grexit that Moussalem spoke about have been replaced by concerns over China’s slowdown, the slump in oil prices, Britain possibly leaving the European Union, Ukraine's tension with Russia, and an immigration crisis that has spread to several European countries.
But Rob Wilkinson, chief executive officer at AEW Europe, which employs 300 people in 10 European offices, wonders whether such concerns really trump attractive real estate deals. For example, his firm recently led transactions in the UK on behalf of US and an Asia Pacific investors in the face of much debate over a potential Brexit. “There is the intellectual debate and there are risks associated with Brexit, but these can be outweighed by the right deals,” says Wilkinson.
A Brexit is in danger of becoming a reality now that British Prime Minister David Cameron has been reported as eyeing June for an ‘In-Out’ EU referendum. Colony's Moussalem said: “The Brexit is in front of us. We will have that discussion. But Brexit is perhaps not a good example (of an issue becoming disproportionate) because there is too much at stake. Cameron is too smart and Europe has too much to lose for Britain to leave the EU. Ukraine and Greece are more dangerous in that their real impact is a lot smaller.”
Johan Bergman, chief executive officer at Niam, a Nordic specialist, has a slightly different take on such issues. He suggests the Nordic region is “boringly uneventful” compared to other territories for much of this to matter. His firm has been on the road this past year raising an €800 million opportunistic fund, and Bergman reports: “We did not spend that much time talking about geopolitical matters. Obviously oil in Norway and asylum seekers in Sweden, yes, but it was more down to business and the Nordics seems more insulated from the rest of Europe, which it isn't of course – it is quite dependent on the rest of Europe.” But Bergman's general viewpoint is that investors are able to differentiate between events hundreds of mile away.
Having asked about the macro-economic climate, PERE next asked our participants where the best risk-adjusted returns could be found.
The question elicited different answers. For Colony Capital, it was in secured credit, special situations, distressed mezzanine, and non-performing loans. “But the great news for all of us is there is no easy thing,” says Moussalem. “We add value by finding opportunities and managing these portfolios and assets, which still presents a great barrier to entry for others.”
For Niam, the best risk-adjusted returns have to found in its home Nordic market. Institutions in the Nordics are “very much in for Grade A property – core, between 4 percent and 5 percent – which to me still makes sense,” says Bergman.” There is still a large enough spread between prime and secondary and therefore good opportunities,” he adds.
Picking up on Colony's predisposition towards credit, AEW's Wilkinson points out his company is involved in senior lending, yet he doesn’t see a significant “value differential” between core equity and core debt per se. The company remains ambivalent between the two. For him, opportunities remain in the small to medium lot sizes in Southern Europe. “In particular where assets don’t fulfil the criteria for a core investor then pricing becomes more interesting but one has to be careful to properly understand the risk profile of an asset,” he says.
Wilkinson counsels that if a manager is prepared to take some risk in the current market, it is unwise to do so with location. “Institutional investors are still not really focused on buying an asset where the lease term is too short or the covenant is a little bit weaker or the structure of the building is not great but could be made better. They are going up the risk curve slightly, but I don't think any of us think about compromising on location anymore.”
Invel founder, Chris Papachristophorou, points out that sometimes the question of where best risk-adjusted returns can come from in Europe depend upon the type of capital source one advises. “If a client wanted core, one cannot say, 'You are wrong'. You respond to your client's demand. That said, I lean towards the comment that we operate where there are barriers to entry where one has to roll up the sleeves and dig deep to find the appropriate transaction. That's what we do.”
In the wake of the global financial crisis of 2008, the roundtable participants suggest Europe possesses a more educated fund manager base after some “natural wastage” occurred. AEW's Wilkinson made the comparison between those buying core now and pre-2008. “I don't see villains like we did, but I do see risk and a challenge in value terms for some investments over the next three to five years because I think cap rates have to go out at some point,” he offers. However, to be clear, Wilkinson adds he is “not a subscriber” to the argument that the market would nosedive. “I do not see huge drops in value. If you look at real estate in Southern Europe, for example, values are anywhere from 20 percent to 25 percent off peak values. This is from eight years ago, and unless something unpredictable happens I am not sure we see the environment that creates villains.”
Picking up the theme of managers operating today being different to pre-2008, Papachristophorou adds that there is simply less leverage. “What puts pressure on a cycle? It is actually leverage. This time around there has not been even close to the same kind of leverage we saw before. I do not see a financial reason for a massive correction especially in a low interest market. Having said that, the risk of leverage is more of a sovereign one than a corporate risk and when you add on the various geopolitical risks then there is no doubt that things can still go wrong.”
He adds: “And, going back to the point about credit, it was definitely a winner when the banks were out of money and you could lend at 500 to 700 basis points, whilst today in order to get attractive returns in a credit strategy you need to move up higher in the capital structure.”
Colony’s Moussalem pitches in a separate risk. “Another would be the European Central Bank easing QE.” He agrees that the senior credit play is over, but argues that as one goes “up the capital stack” regulation is making it extremely difficult for the regular players to borrow at more than 50 percent loan to value. “The cost of each incremental dollar or euro above that threshold makes it increasingly difficult for them to originate.”
Providing an example of more conservative debt levels, Wilkinson adds his firm's value-add fund has 60 percent leverage. “That's a pretty big margin for a value-add fund compared to pre-crisis.”
In addition to there being less stretched leverage models, supply of real estate in Europe is generally low, Colony's Moussalem further pointed out.
The supply versus demand equation of real estate introduced a section on the occupier market. Taking the Nordic market first, Niam's Bergman explains how there is negative supply of office floor space in Stockholm as office-residential conversions has been commonplace: “For two or three years now we have actually had negative addition of office floor space. From a tenant point of view, in offices it looks good. Tenants are demanding different kinds of space, so there is really a need to replace the stock. I think that market makes perfectly good sense.”
Inver’s Papachristophorou is keen to understand how rents are performing outside of Stockholm's central business district. This is because in 2015 Invel entered into a transaction with Ireland's National Asset Management Agency (NAMA) for some UK assets: “We have seen a very different performance in the behavior of rents outside of London where it is much more stagnant.”
Meanwhile, over in Paris, the city is just starting to recover. “Incentives are starting to get eroded,” says AEW's Wilkinson.
Lastly, Colony's Moussalem picks up on there being some question marks over the hospitality sector, especially in the wake of the Paris attacks. He is also interested in other secular shifts. Some incubators are signing up to higher rents compared to traditional blue-chip companies, he argues. Meanwhile, in the retail sector, some physical stores are actually benefitting from the growth in e-trade on the retailers’ websites. On the other hand, as retailers close stores, online traffic drops off.
With such seemingly conflicting or counter-intuitive trends, it must be hard to be an investor coming from outside the region in the vein hope of making sense of it all. But this is what makes Europe interesting and that was essentially the message coming out of the roundtable. Investors are still under-allocated to real estate, which is why so much capital continues to flow into the region; furthermore, the need to diversify their holdings will also likely keep them coming.
Everyone around the table has witnessed the influx of capital, much of which is looking for a reasonably consistent yield, though it is being realistic about what that yield should be. Wilkinson, on behalf of AEW, provides his take on the market: “Of course the UK, France and Germany as markets are popular because of their liquidity, but our view in advising certain clients would be to invest in something that is not a trophy or CBD asset on long leases because those are pretty expensive.” His firm invested in a shopping Centre in Basingstoke to the west of London at the end of last year, and a portfolio of assets from listed UK property company, Segro. “Both were around 6.5 percent cap rates. In relative terms, it is good UK real estate, but not trophy asset types. We see that to be good value. You could make even greater returns in some of the markets in Southern Europe, but if you are talking to a Chinese insurer they are perhaps less likely to start in Spain or Italy.”
In certain markets, core real estate is certainly looking expensive. However, as Colony's Moussalem points out: “What strikes me most is how fast the sentiment changed towards Europe. Not so long ago, the region was viewed as being not investible. People sometimes forget that not so long ago there were discussions about whether the Eurozone would keep together. Fast-forward and Europe has become almost the only investible market.”
Intrinsic merits that investors do see include: positive employment trends, low interest rates, plus limited supply in most asset classes and markets. “On a relative basis, one looks at volatility in emerging markets and in the US, and suddenly one can understand the interest,” says Moussalem.
“What makes Europe exciting is that we have all these markets at different points in the cycle,” concludes Invel's Papachristophorou. That factor, the roundtablers agree, should keep investors interested for some time to come – despite the dramatics that are happening on Europe’s wider stage.
Invel Real Estate Partners
Chris Papachristophorou launched Invel Real Estate Partners in 2013 having been a longstanding servant of Bankers Trust in the 1990s and later Deutsche Bank’s high yielding global real estate business. Invel currently has
€2 billion of AUM and currently focusses on the UK, Italy, Greece, Cyprus and Poland.
Executive Director and Head of Europe
Nadra Moussalem heads up the European business of Colony Capital, the Los Angeles-headquartered firm that went public in 2015. Having joined in 2000, Moussalem has been elevated recently and is responsible for the identification, evaluation, execution and management of European investments. Prior to joining the Colony Capital, Moussalem worked for AXA in Paris in the financial products engineering department.
Chief Executive Officer
Having joined AEW Europe in 2009, Rob Wilkinson has ultimate responsibility for the business’ strategy and execution. During his time with the Paris-based company, he has overseen €20 billion of transactions in the European marketplace and has expanded the footprint including a UK fund management platform. Prior to AEW Europe, he worked at Goodman Group and also held investment banking positions at UBS and Eurohypo.
Chief Executive Officer
Johan Bergman is chief executive officer of Nordic specialist, Niam, which just last month announced the final close of its €800 million Niam Nordic VI. The company also manages core-plus funds. Bergman has been CEO since 2006 having previously worked for 16 years at Skanska. Niam currently has a portfolio of around €2.3 billion investments.