EUROPE NEWS:Regulation by management

With European cap rates reaching or exceeding record territory, the region’s investment managers are having to insist on restraint to an institutional investor base whose appetite for income-generating assets has become insatiable. At a panel entitled ‘Strategies of the Big Players’ at last month’s annual EXPO Real conference in Munich, chaired by PERE, senior executives from CBRE Global Investors, TH Real Estate, AXA Investment Managers – Real Assets and Macquarie Capital shared their experiences from the front line:

PERE: What role do your underlying investors expect real estate to play in their portfolios in the current context?

Jeremy Plummer, CBRE Global Investors: In terms of required return, we’re seeing that progressively coming down as they seek alternatives from low or negative interest rates on bonds. That is putting them under a great deal of pressure to invest for any kind of yield. As such, we’re now acting as a sort of brake to discourage a feeding frenzy in the market happening at too low yields. There are clearly dangers to an investor being happy with a 5 percent total return yield against a zero percent bond yield.

Dennis Lopez, AXA Investment Managers – Real Assets: It is really an unusual time. Take global GDP: if 25 percent is in countries with negative interest rates and 30 percent is in countries with rates under 1 percent, that is 55 percent below 1 percent and that has never happened before. Negative interest rates and quantitative easing are relatively new. This world is putting pressure on real estate yields, which are among the last to face the pressure seen in bonds and stocks. Jeremy is right – we are acting more as a brake – we are much more cautious about how much capital we raise and where we put it.

PERE: How do you cope with your investors applying the pressure to deploy capital?

Timothy Horrocks, TH Real Estate:
We are only prepared to take mandates where we feel we have the specialism and expertise locally to deliver on those strategies. That is a big difference to the last cycle where if someone had an idea, they would be able to raise capital against it. The whole industry has moved on from that time.

PERE: So let’s move on to deployment. How do you deploy wisely in this environment?

Jonathan Harris, Macquarie Capital: In our business, we are advising co-investing with organizations which are trying to respond to the pressure of seeking income-producing real estate. They might do a develop-to-core program. Alternatively, some folks will try to buy businesses that come with a lot of real estate.

JP: I’d add a similar comment. There remains opportunities to access deals through different entry points. Through our Global Investment Partners business we’re actually seeing a higher level of distressed and I agree that develop-to-core is a good method to access the market. We are also willing to structure transactions in creative ways to capture assets. In terms of mainstream buying wholly-owned assets for our core funds and separate accounts in Europe, to put it bluntly, the transaction volumes are running at lower levels than last year.

PERE: Following Brexit, all eyes are on Germany as Europe’s safe-haven real estate market. Is the switch of tag justified?

TH: The German market has been pretty hot all year and, post the summer, prices have accelerated further. Is that down to Brexit? I’m not sure. The difference between now and before in Germany is all the foreign money. Before 2006, the market was seen as boring. But that has its benefits and that has attracted more investors. Do I think Germany will usurp London? I think it will be difficult to displace London from being a global financial capital. Yes, there are issues in the short term, but over 20 years it will not be displaced.

We’re positive on London in the medium term; short term there will be some bumps. London’s office market is in great shape with vacancy at less than 3 percent on new buildings. There is not a lot of supply and Brexit will knock even some of that out. Take even a four- or five-year view and we’re positive.

It is a global meeting place for capital. Not just by country of origin, but also type of capital. So, for every institutional investor sitting on the sidelines which won’t take a view on the currency depreciation, there is a Hong Kong or mainland Chinese investor more than willing to take such a view. My view is we won’t see significant movements in value but lower volume instead.

PERE: Is there are possibility that investors become distracted by currency and interest rates when they should be focused on the real estate? 

For a number of our clients, for which we construct global portfolios, currency markets have far outweighed what has been happening in the real estate markets. Key to us as we set up such mandates is to make it clear who is responsible for the currency risk, and we prefer they are. Currency is not our expertise.

JH: It can be hard to measure but currency has second-order effects. Tourism in the UK is booming; retail spend associated with that is strong; hospitality markets are benefiting accordingly. Manufacturing is improving too. Whether that sustains over the next two to three years as we untangle from this mess, who knows. But in the short term, there have been benefits.

PERE: Besides the UK and Germany, which other European markets are making sense to the ‘big players’?

TH: We’re active in all European markets, but with the strategies we’re pursuing, we’re having to be selective in how we actually access the stock.

For us, I don’t think there are any geographic themes any more. Now, it is about looking for needles in haystacks and those can be anywhere.

PERE: Let’s finish on the topic of risk mitigation. At this point in the cycle, what are the biggest threats to your businesses?

JP: The lesson from the last cycle concerns leverage and that is the temptation today. Debt is almost free, so why wouldn’t you leverage as aggressively as you could? If there is a price correction, the impact on the equity would be just like last time. So one has to be careful about that temptation. A lot of investors are so focused on cash-on-cash yields and so are encouraging you to use leverage. But I think we need to exercise prudence around that.

The days when you see even 65 percent loan-to-value are very few though. The market has generally stayed on the right side of that risk. But I agree the banks are like the canary in the coal mine. When the lending starts getting crazy, that’s a good time to rethink the market.

Who are the ‘Big Players’?

Jeremy Plummer

Head of EMEA and chief executive, CBRE Global Investment Partners, CBRE Global Investors

Dennis Lopez

Global chief investment officer, AXA Investment Managers – Real Assets

Timothy Horrocks

Head of continental Europe, TH Real Estate

Jonathan Harris

Executive director Europe/UK, Macquarie Capital Real Estate Advisers