Earlier this week, in a discreet location just behind the Boulevard de la Croisette in Cannes, PERE met with a large real estate investment manager who said the next big trend to watch out for in Europe is “value-added” propositions. The firm in question apparently is having a serious internal debate about creating a value-added strategy, and it could well end up becoming the next product off its corporate production line later this year.
It was an insightful meeting and perhaps no coincidence that just a few weeks ago a different firm also suggested it was time to examine a value-added strategy. That firm said US investors had stopped worrying about Europe as a place to invest and were now exercising their minds about how best to invest.
From the outside, it seems to make sense that a value-added strategy could work. Real estate fund managers certainly are beginning to see a broadening of interesting deals involving good quality income-producing real estate that nevertheless require asset management to make decent long-term money. The strategy involves going up the risk curve by taking some leasing risk, for example, but keeping things within acceptable parameters to deliver a gross return in the 15 percent to 17 percent region.
This theme of ‘value add’ reverberated throughout MIPIM, even though it often was drowned out by the mood music being piped to the masses, which generally was suggesting greater enthusiasm that we're past the worst in Europe. Here’s to hoping we really are.
According to some, however, discussions about value-added strategies actually expose a conundrum at the moment, which is the real reason they are being talked about.
In order to face sovereign, currency and legal risk in Europe, some US investors want to see opportunistic returns of 20 percent-plus coming out of the region. Meanwhile, there are European investors who don’t believe this is possible anymore. They think those returns at the very best will be in the mid-teens.
This is a real problem because, in the past, an opportunistic manager could raise a fund from investors in different parts of the world that shared the same return expectations. Today, by contrast, there is some fudging going on around the issue. Instead of trying to fit investors into the same opportunistic fund, managers are thinking about creating a value-added proposition to appease Europeans.
The compromise is to launch something that most investors will agree has ‘acceptable’ higher risk in Europe. Indeed, firms are acknowledging that perhaps a commingled fund is not the answer at all because of the tensions described here. Instead, the answer might lie in a value-added segregated account, joint venture or club-type structure involving fewer like-minded investors.
Is it a coincidence that the two firms contemplating a value-added approach happen to be strong in separate account relationships and/or JVs and club-type deals? They also are both good at asset management, with dedicated teams on the ground in Europe to deliver that value-added component. Furthermore, they both seem to believe that we are likely to see more credit available over the next two years to help finance riskier deals.
Chances are, over the next few months, examples will emerge of club-type deals, JVs and separate accounts where the manager is providing access to deals with mid-teen returns. Everything else being equal, for those investors finding cap rate compressions in core real estate no longer tolerable, this has to be a good thing.