UK recovery is in play

Widespread job losses, downgraded economic growth prospects, consumer bills rising – it sounds like the perfect time to launch a UK recovery fund. But will there be enough opportunity for all? By Robin Marriott

Up until now, much of the focus in UK real estate investing has been on distress, as private funds await the predicted wave of sales by banks and highly-indebted investors. Yet opportunity funds are also positioning themselves for UK recovery.

This may seem a little premature, but the trend was confirmed last month in a research document produced by Deutsche Bank's alternative investments arm, RREEF. Releasing the report called “UK Real Estate – an opportunity?,” RREEF highlighted that along with opportunities in secondary sales in unitized funds, private debt and public debt, there would also be interest in areas linked to an upswing in UK economic fortunes.

The firm suggests rental recovery will occur across most sectors in the UK market as early as 2009, before strengthening further in 2010. This prediction, as RREEF says, is dependent on certain things happening and is made before anybody fully understands the extent of the present economic downturn in the UK. And with economists further downgrading economic growth prospects to 1.8 percent of late, that caveat needs to be heeded.

Nevertheless, the areas of interest highlighted include the office market in the west end of London and the M25 office corridor to the west of London. These are expected to recover as early as 2009 making the purchase of real estate with leases that bridge the downturn in rents a “strong counter-cyclical investment opportunity,” according to RREEF.

Also, secondary office assets sold in distress by investors who have breached loan-to-value ratios represent strong value-added opportunities through repositioning and tenant engineering, especially when timed to coincide with an economic recovery. In addition, retail warehousing is a sector to consider if timed to capture an improvement in consumer sentiment.

The fundamental factor that investors must weigh up is whether economic recovery is really going to materialize as strongly as some predict. Recovery can't really happen without banks returning to normal operations or without household bills falling, for example.

But the mispricing that is taking place in some sections of the market may well tip the balance when investors weigh up the recovery play.

RREEF argues that price correction has occurred the fastest in the UK compared with anywhere else in Europe and that downward pricing has been uniform as well as indiscriminate. In other words, repricing has not taken into account underlying performance prospects in certain markets.

For example, the London City office market has been subject to the greatest downward price correction, but RREEF points out that average IPD portfolio data (which holds all assets blended on average rent, not only prime assets) indicates it is only 10 basis points higher than the M25 region and certain UK regional office markets. Both of these markets are less directly affected by the credit crunch and entered a rental growth phase later than the City.

RREEF also compares the London City office market to the west end of London, where office occupation is less reliant on investment banks and other firms directly hit by the credit crunch. The west end office market also has less supply. Yet at the end of 2007 there was a mere 50 basis point difference between City and west end yields for prime assets.

The implication is that opportunities exist on mispricing alone, but when coupled with economic recovery prospects, the opportunity to invest in certain sectors and certain locations looks even more interesting.

There is undoubtedly a pool of money being built up weighing up such opportunities. David Ryland, a partner at SJ Berwin, recently told a PERE roundtable discussion on European real estate that UK recovery funds have been one of two big areas of activity in recent months. (The other being credit opportunity vehicles.)

The logical question is whether there will be enough opportunity to satisfy UK recovery funds. In terms of direct asset investment, private equity firms will not be alone in pursuing such a strategy. And what if the economic recovery is slower than expected and there are fewer forced sellers than hoped for? The consequence will be that opportunistic fund managers looking to populate their vehicles with assets positioned for recovery could be disappointed. In the meantime they are busy raising funds or are simply watching and waiting.

Curzon closes opportunity fund
Curzon Global Partners, the London-based boutique real estate fund manager, has raised €640 million ($960 million) for European Property Investors (EPI) Special Opportunities LP, but expects final commitments to be higher. The pan-Europe vehicle held a first close in February at €215 million, and has since added €425 million of subscriptions, giving it a total of €640 million in equity. However, the final figure was expected to be closer to €800 million at the time of press. This is a follow on to EPI LP which raised €769 million in 2004 targeting 16 percent triple net returns with leverage of up to 70 percent. The latest fund has an expanded mandate, allowing Curzon and its affiliate AEW Europe to provide capital to public real estate companies in need of liquidity.

Catalyst holds second close
London-based investment, asset management and development group Catalyst Capital has held a second close on its latest real estate vehicle, the Catalyst European Property Fund. The fund has closed on €168 million ($260 million), according to people familiar with the matter, however the firm is believed to be targeting €400 million in total with a final close expected this summer. Catalyst has already invested in property in Italy, the UK, France and Germany through its previous fund, the €200 million WCC Europe Fund, with the firm increasingly looking to the Benelux region as well as the emerging markets of Central Europe.

Pirelli to raise first Europe fund
Italy's Pirelli Real Estate plans its first European opportunistic vehicle, declaring it wants to raise €1 billion ($1.5 billion) in equity. Pirelli disclosed the plan while reporting weakened first quarter results last month. In a statement, the firm said it expected a weak first half of the year but that it was confident of a pickup in the second half. The opportunity fund would help increase Pirelli's assets under management in 2008 from €13 billion to almost €18 billion, it said. Pirelli's primary focus has been on residential, commercial property and non-performing loans in Italy and Central and Eastern Europe.

Bahrain targets CEE
Swiss-based Faisal Private Bank, Bahrain-based Shamil Bank and Sharjah Islamic Bank have launched a €150 million ($231 million) Sharia-compliant Central and Eastern European Real Estate vehicle. According to the partners, it will be investing in development opportunities as well as incomegenerating assets in the region. Faisal Private Bank is the investment advisor of the fund, Sharjah Islamic Bank the lead sponsor, and Shamil Bank the subadvisor and co-sponsor. Giovanni Perin, head of investment banking at Faisal Private Bank, said: “We are very pleased with the response of the Bahrain market to this fund, which is aimed at an informed and sophisticated investor-base with very particular demands and interests.