Shopping for real estate

Private equity firms are circling the supermarket group Sainsbury's and putting the spotlight on companies with large property assets. By Robin Marriott

Periodically, a business wisely conducts an inventory check just to make sure it knows what it owns. In the case of Sainsbury's, such a review would likely turn up tons of tomatoes and thousands of cans of baked beans. But foodstuffs have only limited value. They cannot, for example, be used as a defense against private equity suitors. But real estate, especially if it is undervalued on the corporate balance sheet, can.

Ever since it became known that CVC, Blackstone, and Kohlberg Kravis Roberts were eyeing the British supermarket chain, reports have suggested property underpins their interest. Last valued in March 2006 at £7.5 billion (€11 billion; $14 billion), Sainsbury's property holdings offer an efficient way to finance a bid if separated out from the operating business, which itself is worth an estimated £8.8 billion.

At the time of writing, there was still no sign of a reputed €14 billion takeover offer. But whether Sainsbury's is acquired or not, the mooted raid has once again focused attention on the valuable property owned by certain companies, especially British supermarkets, whose share prices seem to have increased in lockstep with real estate companies.

The US business model of efficient balance sheets has been exported to Europe in recent years, but there is still a lot of corporate-owned real estate on the eastern side of the Atlantic. US owner-occupation rates have dropped below 30 percent, but in the UK, that number is still running at around 35 percent, according to property services firm DTZ. On the continent, it is even higher.

If nothing else, the Sainsbury's situation has sparked renewed interest among management teams in preparing for potential approaches from predators. Taking the old adage of “fighting fire with fire,” companies are applying private equity principles in order to defend against, well, private equity.

The obvious options include organizing an embedded op co/prop co corporate structure, which entails splitting the operational assets from the company's real estate. On receiving an approach from an unwanted suitor, the company can defend itself by selling off property assets or leveraging its real estate. Thus, in place of a takeover premium offered by a private equity firm, a company can deliver significant dividends to its shareholders instead.

Sainsbury's has been studying what to do with its portfolio for years, but how many other corporates have yet to complete any serious work? Presumably, quite a few. This is not going unnoticed. Real estate held on the balance sheet is only appraised every few years, which implies that it is currently undervalued given the recent run-up in property prices.

The challenge for private equity real estate is to outsmart these boards before they react. British ones seem to be preparing themselves already, so the natural reaction is to look towards Europe.

In Germany, for example, there is a huge amount of property sitting on corporate balance sheets, but the problem for private equity firms is that many companies are protected by the government. The good news, though, is that there is evidence of a softening.

The unlikely source for this is Volkswagen, maker of reliable cars, but unreliable in its treatment of shareholders. Rules put in place in the 1960s, when the government privatized the auto manufacturer, limited any stockholder to voting rights of 20 percent—even if the shareholder owned more than 20 percent of the company. Last month, such limitations were deemed illegal by the European Court of Justice.

Potential corporate changes in Germany imply that private equity real estate firms can take advantage of opportunities in ways that they may have been unable to do in the past. And it partially explains why so many investors remain bullish on the country despite the significant amount of activity that has already taken place.

As for Sainsbury's, one would imagine something has to give. In 12 months' time, the company will either be owned by a private equity firm, merged with a competitor (unlikely on competition grounds) or, more likely, structured as an op co/prop co with a new real estate financing package in place.

Once that is done, Sainsbury's can get on with the sort of inventory check that should matter to a grocer: the food on its shelves.

Benson Elliot spending reaches €500m
London-based Benson Elliot, the private equity real estate firm launched by Marc Mogull in 2005, has invested a quarter of Benson Elliot Real Estate Partners II following the acquisition of a Parisian office portfolio for €240 million ($312 million). The package of six properties includes the famous Opera Italiens in the city's ninth arrondissement. Benson Elliot has now spent approximately €500 million in three deals since launching the fund last year. The fund, which raised €335 million of equity, has acquisition firepower of €2 billion, according to the firm. It is Mogull's maiden vehicle since leaving Doughty Hanson Real Estate Fund in 2005.

London rents most expensive in the world
The West End of London has topped a survey as the world's most expensive office location. Property services firm Cushman & Wakefield says one square meter of prime office space in London's West End costs approximately €2,000 a year for companies to occupy. That equates to 35 percent more expensive than second place Tokyo, at around €1,500, according to the report Office Space Across the World.

Challenger teams up with Protego
Protego Real Estate Investors, the UK-based European property fund and asset management business, has struck a real estate joint venture with Australia's Challenger Financial Services to invest in core and value-added properties in Europe. Challenger, which has a domestic portfolio valued at some A$650 million ($510 million; €390 million), has a long-term asset allocation target to real estate of 30 percent. Protego said in a statement that it would provide Challenger with a “European-based platform from which to source assets.”

AXA opens Stockholm office
AXA Real Estate Investment Managers, a wholly owned subsidiary of the AXA Investment Managers Group, has opened an office in Stockholm to support its expansion into Scandinavia. Jér^me Arnaud will lead the operation as head of asset management for Sweden, Norway, Finland and Denmark. The new Scandinavian office's main objective will be to manage the existing investment portfolio in the region, which amounts to approximately €700 million ($910 million) of assets.

Aberdeen wins €250m Asian mandate
Aberdeen Property Investors Indirect Investment Management, part of Aberdeen Asset Management's property division, has won a second mandate from the Third Swedish National Pension Fund (AP3), this time for a €250 million ($325 million) investment in an Asian fund of funds portfolio. The pension fund plans to invest the money via Aberdeen in about ten different funds over a four-year period. This is the second time that AP3 has invested with Aberdeen. In December, Aberdeen revealed it had won a mandate to invest a similar amount in a European funds portfolio.