BLUEPRINT: Of chief concern

 Paris, chief executive Jeff Furber, Europe CEO Rob Wilkinson and head of Asia David Schaefer gave a 1,000-foot, executive summary of what they are seeing right now in the private real estate marketplace. The 90-minute discussion was a fluid affair, with a broad range of topics, including the right benchmark for measuring the sector’s performance, comparisons with infrastructure, making the most of a property’s excess capacity, the impact of current politics and being part of an asset management gorilla.

Jonathan Brasse: Imagine I’m an institutional investor with zero knowledge of private real estate investing. But I want to add the asset class to my portfolio. I’m going to need you to give me the 1,000-foot view: good and bad.

Jeff Furber: There’s more good than bad. Certainly, the income component of real estate is attractive to most investors today given sovereign debt yields are so low. The income spread there is historically large. And total returns for real estate, while moderating, have massively outperformed most other asset classes over the last five years or so. Also, it is serving investors as a diversifier from their stocks and bonds portfolios.

David Schaefer: I would add that property is in a pretty good position supply-wise. We haven’t overbuilt globally as we have gone through this cycle.

JF: Debt-wise, too. Lending has remained rational and actually tightened for this point in the cycle – and we are late cycle. Normally in this part of the cycle, you see lending become easier. So this is extraordinary and is what makes this company more bullish than we would ordinarily be.

What is bad about real estate is that we are seeing the lowest yields I have seen in my entire career. But cap rates relative to sovereign debt are still actually quite attractive. This is a place I have never been before.

JB: So in your rhetoric with investors these days you have to talk more about the comparison with other asset classes than historical yields?

Rob Wilkinson: Undoubtedly the conversation is more challenging than five years ago when cap rates were higher. This means that you need to take a long-term view when investing in core and focusing on assets and markets where you see the potential for rental growth.

DS: As Jeff says, cap rates is one of the bad sides. Yields being at historical lows means that cap rate compression is not the way out for any real estate investor, so I think that is putting more focus on the quality of the real estate and what someone does with it.

JB: Let’s talk more tangibly about that. The building we’re sitting in (22 rue du Docteur Lancereaux), what sort of cap rate would I expect to see from it?

RW: This building is in a prime location, but it’s not perfect. It is a renovated ‘B building’ that Unibail has transformed into an ‘A building.’ Look at the comparables. The Morgan Stanley headquarters, around the corner from here, sold for around 3.25 percent, and that was about two-and-a-half years ago. Who would the competition be? There would be local demand – French institutional investors who take comfort from the fact it is in their home market, even while the yield is so low. And, as Jeff says, it is still better than bond yields. Asian capital is still looking, and family offices and other private capital look at this scale of building as well. I have no doubt Unibail-Rodamco will have few problems selling this.

JF: If you had asked all three of us two years ago if yields would go lower in real estate, we would have said ‘no.’ If you asked last year, we would have said ‘no.’ And if you ask us now? We would probably say ‘no.’ Maybe we’ll be wrong three times.

JB: If the asset was on your books, how would you market it and to who?

RW: You would sell it via a full-blown marketing because there is still clearly enough demand for this kind of asset.

JF: This is a good example of how you can still make compelling returns on real estate. Unibail essentially bought a B building in an A location, renovated and leased it up to good tenants. I would venture that they would achieve much higher than core real estate returns, as it is pretty much a basic value-added play.

JB: So we’re in a place where we must redefine the acceptable margin between prime real estate and government bonds?

JF: Yes, but I’m not sure this is a new paradigm. If I think back five years ago, all my clients were asking, what’s going to happen to bad real estate when interest rates go up? What happened was that interest rates went down – then real estate cap rates started following them down.

RW: Real estate and bond yields were on a par immediately before the crisis. Few were looking at the spread at all. It was a crazy time though. Most often there is that premium, and I think typically a spread of 200-300 basis points above bond yields is considered good relative value. If interest rates move up to, say, 3 percent, close to current real estate yields, that’s when things will definitely start to change. If interest rates move 100bps tomorrow, that won’t change the picture that much.

DS: How that relationship plays out in the future is important, but it is also worth looking at the spread between prime grade A and good quality B assets. There is a recognition you can get some pretty good income returns out of grade B assets for marginally-incremental risk.

JB: And this building is a case in point?

RW: The spread between core and non-core a few years ago was 300-400bps. Now it has probably widened, but this building would be in the core bracket. That gap between core and non-core is now much wider than if you went back 10 years when it was as little as 100bps.

JB: I’d like to reflect on some high-hitting news run on our website over recent weeks. Invesco published a report that found sovereign wealth funds are finding infrastructure less attractive, and that should benefit real estate allocations. Do you agree real estate can mop up more of an investor’s real assets allocation?

JF: There is no question that ‘alternatives’ are becoming a much bigger piece of institutional portfolios as a way to achieve returns. Most investors have a return target of 7 percent and, as said already, you can’t get that from bonds today. Whether you can get it from stocks, I’m not sure. Alternatives as a class, which comprises real estate, infrastructure, timber and private equity, definitely has expanded.

RW: But I think some investors have struggled to find the assets in the other classes.

JF: Right. We are not in infrastructure, but, anecdotally, it doesn’t seem in relative terms that a lot of money has been deployed in infrastructure. There is a lot of demand, but I am not sure there is as much stock available.

JB: The institutionalization of the real asset classes has happened at varying paces too, with real estate ahead of infrastructure. That must have played a part in this distinction.

RW: We now have a global capital markets phenomenon happening in real estate. This is the first time you have almost every region of the world looking to invest in real estate in every other region. In Europe, we have US, European and Asia-Pac investors all wanting European real estate. The same can be applied to the US and Asia. It has gone global.

DS: In Asia 10 years ago, you didn’t have CPPIB and others coming at it with large chunks of capital that they are today. At the same time, you didn’t have the same size of institutional standard market. Both have grown significantly, creating a lot more liquidity. Which is, undoubtedly, a good thing for the asset class.

JB: But while there is capital demand, there are also challenges when it comes to deployment right now. In May, in an onstage interview with Paul Mouchakkaa of CalPERS, he said he was seeing just 25 percent of a typical $500 million commitment actually invested.

DS: That is part of the challenge: putting large sums of money to work across the world.

RW: It is going to represent challenges in terms of a manager being able to deliver. It means we have to be more creative in how we can help these investors build up sizable real estate exposures. We also need to be patient and careful how we invest.

JF: But it is precisely why it is good to manage along the risk-reward spectrum, whether it is senior debt at a 2 percent yield or opportunistic at 15 percent.

JB: At PERE’s Europe Summit in May, private real estate managers were facing an existential question in terms of how they reconciled an increasing mismatch between the long-dated, liability-matching institutional capital they serve and the way tenants want to occupy and pay for their real estate. Your thoughts?

JF: I don’t think lease terms have changed materially in the last 10 years. Also, on the other side of the coin, a lot of our clients see real estate as an inflation hedge. In that regard, investing in, say, apartments are good as they are run on one-year leases. That is an example of how shorter leases can achieve what investors are looking for, even if they don’t match their long-dated capital.

RW: In Europe, there are shorter leases so we look harder at the quality of the underlying real estate to ensure, statistically, a property is occupied for as long as a long-term lease and the same tenure of income is generated. Just because a property has a 15-year lease, that doesn’t necessarily make it a perfect match for an investor’s long-term liability management.

DS: In Asia, we’ve always had shorter-term leases. They work best in well-located property in growth markets. As a tenant, on the other hand, a three-year lease, for example, puts you on the opposite side of that equation.

JB: Is this true for every property asset class? Surely retail is one exception.

JF: There has been a complete revolution going on in retail. But outside of that, we’re not seeing material differences.

RW: But even in retail, often tenants invest in the assets they occupy and so are keen to sign up to long leases, then amortize their expensive fit-outs over that period. We’re not facing fundamental shifts in leases. What has affected the occupier market are things like e-tailing, the economy as a whole and how that impacts office space or changing types of retail. Those things have more of a direct impact on how we look at investment. Most of our clients are in it for the real estate returns and not just the fifteen-year lease.

JB: Another topic that featured prominently at the conference was maximizing a property’s capacity, the premise being that the sector has too much unused space, even when it is leased up.

DS: A good question to ask is how the space is configured and whether the previous owner was getting the most out of it. For instance, the car parking: is there too much or is it worth converting some into more offices?

RW: Take a shopping center, for example. You could add 10 cents to the car parking hourly rate and create extra income. But is that going to impact demand for the space? There’s been talk about the use of the excess capacity in offices, but I think when you rent office space you expect it to stay yours. On the other hand, there’s greater demand for WeWork-style space than previously, and I expect that trend to continue, but not the sort of growth we’ve seen in e-tailing.

JB: Circling back to my original question taken from the perspective of an institutional investor with zero exposure to private real estate. What is the overriding indicator to watch to determine when working out where and when to dive in?

JF: The real thing driving long-term or medium-term trends is interest rates. It is those that have allowed markets to get back to stability following the global financial crisis. And it is thanks to those that there has been an up-market. We think rates are going to stay low. In the US, the Fed has stated they are going to raise short rates. I think that will flatten out the yield curve because long rates are still at quite a premium to other countries.

RW: In Europe, it is hard to see what the catalyst for a change in interest rates would be.

JF: So, lower for longer has been the dominant theme for the last five years and is going to continue to be for the next 24 months. Beyond that, we don’t forecast much of anything.

Left to their own devices

AEW’s growth is an integral part of the growth plans of parent Natixis, which is currently underexposed to real estate

Plenty is known about AEW as a real estate investment management business, but far less about its relationship with parent company, the Paris-based global asset manager Natixis Asset Management. A giant in private real estate, AEW’s assets nonetheless account for just 7 percent of the $895 billion on Natixis’s books, even if it is the third biggest of the 20 platforms it owns.

Furber, who has run AEW since 2000, says: “We are the largest alternatives platform at Natixis, too. But when you consider most institutional investors are increasing their alternatives allocations and manager counts, you’ll understand that they are very interested in us continuing to grow.”

As such, Furber agrees it is worth considering Natixis like an institutional investor and, given most institutional allocations to property are around 10 percent currently, its exposure to real estate through AEW is lower than it should be. Therefore, the parent’s expectation is for the real estate percentage of its assets to move upwards, to which AEW has a plan to grow assets under management to approximately $90 billion in 2020 from $65 billion today.

Furber says most of the firm’s growth so far has been organic. “Acquisitions have been a part of it, but as we look forward, in the US and Europe, we will continue organically growing.”

Asia, however, is where corporate purchases are more likely. In line with Natixis’s appetite for a greater Asian presence, AEW could well take out the check book to bolster what is the smallest of its three businesses by far, with approximately

$5 billion of assets. “We would definitely look at that and Natixis would be very interested in helping us,” says Furber.

Schaefer describes the task of growing the Asia business as his “job description” but he and Furber give the impression he will be able to create a business largely his way, with little or no disturbance from the parent company. Indeed, autonomy is a central ethos held by both Natixis and AEW. “We all operate like that,” Furber states. “Minute by minute, day to day they are not involved. That goes for investment and personnel decisions.”

The connection between parent and affiliate happens at the board level. “We will write our business plan for the year, present it to Natixis and, together, agree on a route forward. They are a very supportive parent company.”

Schaefer says: “It allows me, as regional CEO, to run my organization and everyone in it in an entrepreneurial way. There’s no top-down method; it’s all bottom-up.”

A larger Asia piece should complete an otherwise fully international, cross-border offering. Furber says: “We know real estate is a local business and that investors need to invest locally with local teams. Particularly over the last five years, we have seen capital flows go every which way. That is crazy compared to 2000 when we were a US company with clients in the US. Today, we are in 25 countries and they are all investing in different directions.”


Established: 1988
Headquarters: Boston, Paris, Hong Kong
Offices: 15
Staff: approximately 600
AUM: $64.4 billion (regionally split: US $33.3 billion; Europe $29.1 billion; Asia $2 billion)
Current strategies:
US: Pan-country, multi-asset class and sector specific core open and closed-ended commingled funds and separate accounts, value-add and opportunistic closed-ended commingled funds and separate accounts; equities funds
Europe: Pan-regional, country specific, multi-asset class and sector specific core-plus and value-add closed-ended commingled funds and separate accounts
Asia: Pan-regional, multi-asset class Asia value-add closed-ended commingled funds
Incoming strategies:
Pan-regional, open-ended core funds in Europe and Asia
Performance (gross equity multiple since inception)*:
US: opportunistic funds: 1.8x
Europe: non-core strategies: 2x
Asia: value-add funds: 1.5x

*core strategies in line with local indexes
Performance numbers not confirmed by AEW

AEW on…


JF: We did one of their very first spaces, and I remember debating with our investment committee about whether they were a real company and whether they would survive. We just didn’t know. It was a B building, so we thought we’d take a chance. We ended up turning a very good profit because by the time we sold, WeWork was considered acceptable. But we wouldn’t want to fill an entire building with that type of tenant.

DS: We just signed a lease for a building in Seoul with the Korean equivalent of WeWork. The difference was they paid for the fit-out. We like that. They’ve only taken about 15-20 percent of our building. Clearly it is a viable business model.


RW: One area where costs have increased considerably is environmental. We are driving this agenda because, ultimately, there is payback. Much of that comes from how the occupier looks at the building. If you have one building that has less of a carbon footprint and another, there is only one winner. Further, more efficient, open-plan property comes with less costs versus buildings that require more partitions and air conditioning. Some clients are more sensitive to ESG, although it tends to be felt more in separate accounts than in funds.


JF: In Europe, the geopolitical environment has been uncertain since Brexit, the French election and, also to a degree, Trump. We have felt a slowdown in Europe, as a result. Things seem to be straightening themselves out. But we can’t predict political factors any more than we can predict interest rates or currencies. Either way, we will modulate our activities in a region accordingly.


RW: Terrorism per se doesn’t seem to necessarily impact on mature or gateway cities. Having said that, certain aspects of the real estate industry have been affected on the periphery. Hotels in Paris, for example, were badly affected when it was attacked. Some high-end retail was affected, but it bounced back quickly. The impact is short-term, life goes on.

Hit rates

In an increasingly competitive marketplace, successfully bidding for assets is becoming harder for everyone. With that in mind, PERE asked AEW’s senior executives for their respective bid-to-hit rates

Region Rate
US 15%
Europe >20%
Asia 30%

Source: AEW

Furber: This speaks to the transparency of the markets. The US is the most transparent, followed by Europe, and Asia is by far the least transparent. These numbers are also lower today than they were five years ago. In the US, the were double today’s rate; in Europe, they were higher, but not double, the same in Asia. I’d also add that, before the sovereign wealth funds came into the market, we’d get a much higher percentage of our bids in core real estate than today.