Europe’s real estate recovery gains momentum
After years of facing a brutal combination of global tail risks and local head winds, European real estate markets appear to be gathering steam in both volume and breadth. While the global property investment market is predicted to grow by around 6 percent this year, European real estate markets generally experienced a more robust year-on-year progress in 2013.
The biggest clean-up in banking history is well under way in Europe, and many European countries are showing signs that they have battled the sovereign debt crisis successfully and are beginning to move in a healthier direction, quarter by quarter.
European commercial real estate investment witnessed its strongest third quarter since 2007 -- nearly 18 percent above the same quarter in 2012. Annual 2013 volume is estimated to reach €145 billion. Importantly, foreign buyers accounted for nearly 45 percent of all European real estate transactions by value, indicating growing investor confidence in Europe’s nascent recovery.
Commercial real estate investment in core Western European markets (UK, Germany and France) accounted for more than 75 percent of the European total with particularly strong quarterly increases over 2012 ranging from 20-40 percent.
Cliffs vs. tapers: receding macro risk
Just one year ago, Global investors were facing the triple threat of a Chinese market melt-down, spreading European sovereign defaults and the US “fiscal cliff.” These macro risks have since receded, and even the language of risk changed in 2013. Who could have imagined just a few short months ago that Spain would be considered the new “darling” of European opportunistic real estate investors, while Germany’s thrift was criticized as the root cause of European financial woes?
While none of the past year’s macro risks have been eliminated altogether, investor sentiment is discounting the possibility of one or more of these risks actually occurring -- absent some unforeseen external economic shock. Compounding the litany of global tail risks last year, European real estate investors have also faced a range of local market headwinds, including the corrosive effects of austerity measures (such as lower government spending and higher taxes); unacceptably high levels of unemployment or underemployment; and a wave of global consolidation and downsizing that put pressure on corporate occupancy demand.
As with global tail risks, regional European headwinds have far from disappeared, but there is growing evidence that these trends appear to be diminishing in a range of European countries and local real estate markets.
Real asset rotation
Bolstering the positive effects of diminishing global and European investment risk is the phenomena of a growing shift to real assets amongst yield starved investors. Given the relative size of global bond and equity markets, even a nominal rotation from paper into real estate assets has a magnified impact on property markets. In fact JLL recently estimated that a 1.2 percent reallocation of cash held by the top 30 largest sovereign wealth funds towards real estate would increase capital allocations by US$50 billion.
In private equity space, fundraising targeting real assets has exceeded 2012 levels, and a number of major funds are rotating more of their AUM into real estate and building new in-house real estate investments teams across Europe. A parallel rotation is occurring with insurance funds both in real estate equity and debt space.
In addition to the rotation by insurance and private equity funds, a number of sovereign wealth funds that had little or no exposure to real estate in the past are moving into the sector, basis point by basis point. Global sovereign wealth funds now manage more than US$5 trillion worth of assets and more than 50 percent of these funds invest in real estate. It is estimated that SWFs will allocate more than US$180 billion to real estate, and more of them are making direct investments with their own real estate professionals. While many SWFs have targeted the North American real estate market, SWFs are having a growing impact in Europe, which is boosting the pace of recovery.
Pension funds are also shifting some of their real estate portfolio allocations. Notable examples such as The Canadian Pension Plan Investment Board (CPPIB), the National Pension Service of Korea (NPS) and the Government Pension Fund of Norway have boosted their real estate allocation rotations and executed major real estate transactions in Europe.
This grand real asset rotation is being driven by a range of factors including low domestic bond returns, the desire to diversify immense pools of cash and a conviction that Europe is still in the early days of a recovery across a range of real estate asset classes.
Asian real estate capital in European real estate
While North American and Middle Eastern investors drove increased investment in European commercial real estate, one of the more significant new sources of real estate capital is coming from Asia. After considerable speculation, Asian insurance companies, pension funds, SOEs (State Owned Enterprises), and Sovereign Wealth Funds are all stealing headlines with landmark real estate transactions in Europe. Chinese insurance funds alone reportedly have US$1.2 trillion in total assets and an increasing amount available for domestic and foreign real estate investment.
For years industry pundits have been captivated by the prospect of vast pools of Asian capital being deployed in Western real estate markets. However, the speed with which trophy deals have been announced in 2013 have caught many real estate professionals by surprise. Asian investors can also point to successful exits in European markets to demonstrate that there is good money to be made by trading assets, even in the super-prime London market.
Notable investors from China in 2013 included Ping An, CIC, ABP, Dailan Wanda, Ginko Tree, ZhongRong Group, and the Bank of China. Outside of China, European Real estate has been targeted by a wide range of Pan-Asian institutional investors from Singapore, Korea, Malaysia, Taiwan, Japan and Australia.
Narrowing CRE debt gap The current CRE debt gap in Europe is estimated to be somewhere in the range of between €450 and 750 billion, which would still be a material reduction over the gap that existed just a few years ago. However, there is no consensus amongst bankers as to whether or not alternative lenders (such as private equity debt funds and insurance companies) have the capacity to bridge all or only a portion of the gap.
Banks are still in an early phase of reducing their real estate loan books, and a number of traditional real estate lenders have either withdrawn from the European market altogether or concentrated lending in their home markets. In addition, regulatory requirements requiring increased reserves could widen the debt gap and tighten lending requirements.
In addition to the easing effect of alternative lending, bond markets have been an increasing source of debt for property companies. Real estate bond issuance in Europe is estimated to reach €17 billion this year, and the corporate bond market is becoming an increasingly popular avenue of finance for European real estate companies looking to repay existing debt. European capital markets are also doing their part by fuelling a slowly recovering CMBS market which could total US$80 billion this year -- although still a far cry from the pre-crisis CMBS peak of US$230 billion.
While European office sector performance was subdued, and prime retail remained consistently strong, traditionally less-favored real estate sectors reached new peaks in 2013.
The logistics sector woke up with a bang in 2013, driven by renewed investor interest in the sector, including private equity platforms sponsored by Brookfield, TPG and Blackstone and a flurry of new investments by industry heavyweights such as Goodman and Prologis. European industrial investment volumes reached €5 billion in the first half of 2013, which was the highest reported volume post Lehman.
Various residential sector segments from single family homes to student accommodation and serviced apartments also attracted increased investor interest. Foreign investors from Greece to Nigeria targeted residential property, often driven by the offer of residency permits and protection from high taxes and political instability at home. In London alone, international residential investors snapped up billions of pounds of luxury properties, pushing up new-build home prices by more than 50 percent since 2009.
The European hotel sector also rebounded in 2013. Hotel investment across Europe soared 53 percent to €8.2 billion in the first three quarters of the year – almost 70 percent above 2012 levels. Dominant hotel investor groups included sovereign wealth funds, private equity players and Asian investors, with a strong focus on the UK’s diversified and liquid hospitality market.
Europe vs. the rest of the world
Institutional real estate investors regularly weigh the comparative risks and rewards of investing in particular countries, regions and cities. While European real estate markets are becoming increasingly segmented, and most emerging European real estate markets have since converged with their Western neighbors, cross-border investors often contrast continental and individual gateway city risks and rewards for comparative benchmarks, even if only to test and market their own portfolio diversification theories.
Even if the European recovery remains constrained and corporate occupier demand subdued, the global real asset rotation should continue to propel real estate investors up the risk curve in the year ahead.
The US real estate market has been a common point of comparison with Europe. The US economy has been growing at an annual rate of 2.8 percent, well above the predicted 2 percent rate earlier this year and significantly above the Euro zone’s relatively anaemic growth in 2013. While warning signs about the consistency of a US recovery abound, it is widely believed that US real estate assets re-priced more quickly and widely after the onset of the financial crisis. Following this re-pricing, the housing sector has been one of the bright spots. Residential housing investment rose almost 15 percent in the third quarter and these housing trends are fuelling an interest in “reo-to-rental” securitizations of tens of thousands of residential properties that were repossessed in the depths of the financial crisis.
The Pan-Asian real estate investment picture is more complicated and is a more difficult point of comparison for global investors, largely because of structural investment barriers in places like China and Southeast Asian emerging real estate markets. However, intra-regional capital real estate flows remain strong, and transaction activity in 2013 in the Asia Pacific region is likely to reach US$120 billion, which would be on a par with 2007 as the largest volume on record.
While emerging and frontier markets have been buffeted by financial and political risks this year, the macro forces driving global real estate markets are pushing real estate capital into new markets such as Southeast Asia and Africa -- a trend that should gather steam in the year ahead.
2014 and Beyond
Even if the European economic recovery remains constrained and corporate occupier demand subdued, the global real asset rotation and navigating CRE debt gap should continue to propel real estate investment up the risk curve in 2014. The growing participation of larger institutional players also signals larger deals in core markets and a need to identify opportunities in secondary cities and peripheral European markets where there are better prospects for yield compression. This is good news for sellers of real estate assets and debt as well as savvy deal originators who can find off-market opportunities in an increasingly crowded field.