Sophie van Oosterom is standing on the balcony of a private apartment on Boulevard de la Croisette, in Cannes, France, overlooking the Mediterranean Sea. She is talking about an informal, but often-used, method of gauging the real estate market: the size of the boats at MIPIM.
Van Oosterom, the EMEA chief investment officer at CBRE Global Investors, recounts that at MIPIM 2007 – during the peak of the last real estate cycle – there was an enormous cruise ship in the water. Draped across the watercraft was a tremendous banner of a large institutional asset manager across it.
“You could see that banner from miles away,” van Oosterom recalls. Since then, however, the Amsterdam-based property executive has not seen any boats at MIPIM approaching the scale of that vessel. “So that suggests that the market hasn’t yet gone back to that peak level,” she jokes.
In sheer numbers, MIPIM 2016 last month was vibrant as ever – attracting 21,400 participants to the world-famous Cote D’Azur. The investment sentiment, however, was noticeably less exuberant than it had been the year before – dampened by what some are calling the top of the market, as well as the threat of a Brexit, geopolitical tensions, market volatility and a potential global recession.
“This is the first time in a few years where the mood hasn’t been bullish,” observes Desi Co, managing partner at San Francisco-based advisory firm Accord Group. Adds Jocelyn Laudet, founder of Paris-based advisory firm Evidence Capital: “Last year was extremely enthusiastic. Now, people are more cautious in putting capital to work.”
Joe Valente, head of research and strategy of global real assets at JP Morgan Asset Management, also has observed the stark contrast in mood between the last two MIPIM conferences. “Last year, everyone was really up, it was an effervescent year,” he says. “The market has shifted, and the pendulum has swung very noticeably for prime assets. Investors are taking a pause for breath.”
Indeed, the newly cautious approach to real estate investing is most prominently reflected in the recent surge in demand for core assets. According to CBRE’s 2016 EMEA Investor Intentions Survey, which was released at the conference, the percentage of investors which view core assets as the most attractive part of the real estate market rose from 29 percent last year to 41 percent in 2016.
The opposite of cautious
Interestingly, however, none of the private equity real estate professionals that PERE spoke with considered traditional core real estate – prime assets in prime markets – to be cautious investing. SaidValente: “There is much more risk associated with those assets, because if anything happens to interest rates, there’s very little room for maneuver.”
Instead, JP Morgan’s investment approach has been “buying the best assets in institutional non-prime markets, where there is domestic capital and domestic liquidity.” In such markets, where capital values are still below their peak and where a recovery is only beginning to take hold, investments can be expected to outperform their return expectations, Valente says.
Cologne, Germany would fit this profile of a non-prime market. While the city is not known to attract large amounts of global capital, it draws German insurance company money but has not significantly repriced, with yields still above their historical levels and rents approximately 15 percent below their peak, according to Valente.
He acknowledges that the average lot size in Cologne is about $20 million, just one-tenth of the average $200 million lot size in the major European markets of London, Paris and Frankfurt. “You need to think of a different means of actually accessing the market,” Valente says.
However, the downside risk in a non-prime market like Cologne is significantly less than its prime market counterparts. According to Valente, the capitalization rates in the city would need to move 150 basis points before investors would lose their money on a transaction. By comparison, cap rates would need to move only 50 basis points in London and 50 basis points to 75 basis points in Paris and Munich for the same to happen in those markets, he says.
CBRE GI also has witnessed the pendulum swing back into core. “The core markets that we’re in are very competitive,” says van Oosterom. “Some parties that ventured out into value-add are reconsidering core again.”
However, the real estate investment manager is staying in the same core markets, but adding value by pursuing different strategies. “We’re going deeper into the same markets, using our on-the-ground teams,” says van Oosterom. “But we’re not really going up the risk curve.” CBRE GI, for example, was very keen on increasing its investments in the logistics sector in Europe last year. “It’s a very liquid market right now, and we foresee more rental growth in the logistics market,” she says.
Not every firm is necessarily remaining in the core space in Europe, however. LaSalle Investment Management, for example, expects to do more value-add investments, which involve repositioning primarily office properties into Grade A assets and taking leasing risk on those redevelopments, with a particular focus on the UK and France.
Even so, Simon Marrison, LaSalle chief executive in Europe, says that the firm has become more careful and selective in underwriting its investments in the region. “You have to be a little more cautious,” he says. “If it’s a repositioning opportunity, is it because the location is not good enough, or was the previous owner capital-starved? There needs to be a lot more analysis.”
LaSalle consequently has been very deliberate in choosing the locations of its investments. For example, the investment manager has zeroed in on transport locations in areas of major European cities that are undergoing significant redevelopment.
“There’s several cities where there are emerging locations being created because of infrastructure changes,” he says. These spots include Paris’ Clichy-Batignolles, where an extension of the city’s high-speed metro line is currently being constructed, as well as areas of Munich that are being overhauled, such as Arnulfpark and Parkstadt.
At the same time, Marrison notes that some investors are more interested in selling than repositioning properties. “There are a lot of investors that are purely income-oriented rather than income-plus,” he says.
Indeed, in light of concerns about a potential real estate correction, managers and investors alike have been exercising caution through robust sell-off activity. According to the CBRE survey, 43 percent of respondents expected their selling activity to increase this year. Interestingly, however, nearly half of survey participants also expected their purchasing activity to be higher than last year, compared with 15 percent who projected being less active buyers.
According to Co, one of the new themes in European real estate investing is the convergence of both of these acquisition and disposition trends. “We like shortening the duration of investments so there is high cash-on-cash yield,” he says. “A significant portion of investor capital coming back early ensures investors that their investment will be significantly de-risked during a period of greater uncertainty.”
As many unknowns continue to loom overhead in Europe, tensions remain high regarding real estate investing in the region. “There are many potential black swan events out there,” says van Oosterom. Even a relatively minor trend, such as exchange rates rising, could have an impact on exports, which could in turn have a negative impact on real estate demand, adds Marrison. “One external factor can knock things slightly off balance,” he says.
Yet, in spite of the macroeconomic and political worries, volatile equities markets and bonds offering little yield will mean demand for real estate is set to increase again in 2016 which only increases the pressure to deploy capital. The rhetoric from MIPIM was that it will be done cautiously.