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Private Equity Impacts European Real Estate

Politicians have sometimes derided private equity investors as locusts, but many European real estate professionals believe the free-wheeling funds are actually more like bees - helpful creatures that have broadened the European commercial real estate market and made the economy as a whole more efficient.

Unlike the United States, where private equity has focused on taking REITs private, in Europe, it's had much more dramatic and positive effects, experts say.

In the United Kingdom, for instance, private equity investors have pushed a number of companies to spin off under-valued real estate assets. "Where we've seen private equity be most active is obviously buying asset-rich businesses and then adopting some sort of sales-leaseback or op-co/prop-co structure," says Mike Bryant, director of business development for GE Real Estate in London.

KKR's recent Alliance-Boots deal, for example, had a large real estate component. While some analysts were puzzled why KKR and vice chairman Stefano Pessina would offer £11 billion for the British retail pharmacy company - an amount that was roughly 27 times more than earnings - others pointed to the company's property portfolio, which is estimated at £1 billion to £2 billion. Similar deals that will tap valuable real estate assets are reportedly being considered for two large UK grocery chains, Sainsbury's and Tesco.

In Germany, private equity has had an even greater impact. While corporate real estate carve-out deals have been popular there as well, private equity investors have focused more on apartment sales, often from state pension administrators and other quasi-public entities. In 2006, for example, London-based Terra Firma orchestrated one of the largest private equity deals in Europe, paying €6.1 billion (or $8.2 billion) for 138,000 units sold by German utility company E.ON.

That same year, U.S.-based private equity firm Fortress bought 47,600 housing units when it acquired Woba Dresden, an apartment owner and manager. That deal followed the €1.5 billion (or $2.02 billion) acquisition of 27,000 units from public-sector bank NordLB in 2005.

Although private equity managers aren't eager to publicize the numbers, some of these deals paid off handsomely for investors, experts note. Thomas Beyerle, head of research and strategy at DEGI, the Germany property fund division of Allianz, estimates investors who bought large residential portfolios between 2003 and 2005, early in Germany's recovery, earned annual yields of 15 percent to 23 percent.

Creating liquidity

These private equity deals have had some obvious benefits: billions of Euros' worth of office and apartment properties are now being professionally managed for the first time.

"This new generation of owners, they define client care and tenant care somewhat differently from the good old institutions, which didn't look after their tenants that well," says Martin Brühl, head of the German office of Cushman & Wakefield.

Brühl also notes that private equity has created far more liquidity in the market, encouraging more investment activity. Moreover, the increased deal-flow has served to reduce lending rates, he contends, since banks now feel more secure about recouping their money in the event of a default.

And, as many of Germany's major private equity investors have sold their interests to core value investors or took their portfolios public, more property is now part of publicly traded entities, according to Hendrik Broeker, national director of corporate finance for Jones Lang LaSalle in Germany. In fact, the proportion of commercial property accessible for investment has increased dramatically because of private equity deals, according to Paul Kennedy, head of European research at INVESCO Real Estate in London.

All that buying and selling has generated much more information in the market, Brühl says, improving transparency and giving foreign investors more complete information than they once had.

As a result, some experts say that local real estate equity indexes are becoming more reliable indicators of current value than they once were. "It means that things like German DID index of German real estate performance, the equivalent of NAREIT, is going to start to deliver a lot more realistic performance numbers," Kennedy says.

Political backlash

But, private equity players haven't been cheered for their activity. Germany is hoping to add more hedge fund regulation. And, Nicolas Sarkozy, France's new conservative president, has made noises of disapproval, publicly excoriating hedge funds that "that buy up a company, [and] sell it off in pieces."

INVESCO's Kennedy expects a backlash to continue. "It's inevitable. When you create the perception that you're creating value or selling companies for more than you bought them for, or selling pieces of them for more than you bought them for, there's a suspicion that it's the Establishment ganging up on the little man," he says. But, that perception is incorrect, he says, adding that such deals generally result in a net gain of jobs.

Other issues may be making some private equity deals less attractive as well. One is simply that shareholders are more aware of real estate values now. For example, even as private equity buyers began circling around Sainsbury's, the UK grocery chain, the company's stock price rose to reflect the underlying real estate assets - a move that reduced the rationale for a takeover, GE's Bryant pointed out.

At the same time, some companies are now devising ways to make their real estate unattractive to private equity investors - either by spinning it off themselves or by making its divestiture impossible.

One gambit now under consideration by a major UK retailer: transferring ownership of real estate assets to the employee pension fund, where it can't be touched by corporate raiders, according to Peter Hobbs, director of European research for RREEF/DB Real Estate in London. It's a strategy that might keep the company off the block, but could have some unintended consequences, he says, particularly if it prevents companies from diversifying assets beyond the fortunes of the company.

As rewards decline and the risks of spin-offs and government sales grow, some observers believe that private equity players may soon fly over to a fresh clover patch: distress sales. The biggest deals will soon emerge from the turmoil in some of Europe's overheated markets, Hobbs predicts. "Markets that have become overheated both in terms of supply being built and supply will likely be affected," he says.

Parts of Central Europe, as well as portions of the U.K. and Spain, could emerge as attractive markets for private equity investors. If that happens, Hobbs says that private equity will serve yet another valuable function - the buyer of last resort.

European private equity deals
Buyer	Seller	Price
KohlbergKravis Roberts	Alliance Boots (retail)	€16 billion
Fortress Investment Group	WOBA Dresden GmBH (multifamily)	€1.7 billion
Whitehall Street Fund	KarstadtQuelle (retail)	€4.4 billion
Laurence Danon	Printemps (retail)	€1.1 billion
Dubai International Capital	Travelodge Hotels (hotel)	€978 million
Source: GREM research

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