A Long Shadow: Investors eager for re-pricing of European property

More than €50 billion of equity capital is targeting European commercial real estate today, according to Jones Lang LaSalle, yet investment sales activity is still sluggish, and buyers continue to find it difficult to obtain debt financing.

Institutions and third-party money managers, opportunity funds, sovereign wealth funds and German open-ended funds are looking for opportunities to enter the market. As the year progresses, experts expect investment activity to heat up, with these opportunistic investors acquiring quality assets at higher yields from distressed sellers. "We're already seeing investors make their move," says Giles Wilcox, head of Savills' cross-border investment team in the UK.

For example, British Land recently sold a 50 percent stake in its Meadowhall shopping center to London & Stamford Property, an opportunity fund managed by Raymond Mould and Patrick Vaughan, two well-known European real estate magnates. The fund made the acquisition with its joint venture partner Cavendish, which is backed by an Abu Dhabi-based sovereign wealth fund.

London & Stamford purchased the stake for £587.7 million with an initial yield of 6.75 percent, according to British Land, a UK-based REIT. The 1.5-million-square-foot center, which was valued at £1.4bn in September 2008, is one of only six out-of-town super-regional shopping malls in the UK.

Industry experts say British Land needed the cash from the sale to pay off some debts that are maturing soon. However, the REIT said in a statement the sale is just "one of a number of actions by which British Land is able to increase its financial flexibility."

Top investment target
Although many experts contend the Meadowhall deal is the beginning of a trend, investment activity in European commercial real estate will still be moderate in 2009 compared to previous years as Europe's economy struggles.

Uncertainty in the credit markets will "cast a long shadow over Europe," according to Moody's Economy.com. European economies contracted for much of 2008, pushing the region into recession. France and the UK are not expected to return to positive growth until first quarter 2010, and Germany and Japan are not expected to recover until second quarter 2010. Meanwhile, Central and Eastern Europe are expected to suffer prolonged and severe recessions because of the de-leveraging that must occur.

Cushman & Wakefield’s Investment Atlas 2009 predicts global investment volumes will fall again this year to $412 billion. Global investment in commercial property fell 59 percent in 2008 to $435 billion, down from 2007’s record total of $1.05 billion. This was the lowest annual total since 2004 with a significant decline in investment from foreign investors.

North America ceded its position as the top global investment target to Europe, which saw commercial real estate investment decline 52 percent to $178 billion from $367 billion, according to Cushman & Wakefield. As the world’s most popular investment destination, Europe accounted for 41 percent of all transactions in 2008. The UK accounted for 9 percent or $37.1 billion of investment, while Germany represented roughly 7 percent, or $28.8 billion.

Cross border investment in Europe, which has represented an increasing share of activity for eight consecutive years, saw its percentage of total activity decrease slightly for the first time during 2008, dropping from 63 percent to 60 percent, according to Jones Lang LaSalle.

"Although the European market is still dominated by foreign investors, a growing number of nationals are re-visiting their own markets," says Katja Huitikka, senior underwriter for Stewart Title Limited’s European operations. "And, there are more arrangements where local and foreign investors are working together."

Steve Collins, managing director of Jones Lang LaSalle’s International Capital Group, says Germany's closed-end funds are not active in the market, nor are Spanish investors, which have seen their fortunes wane with their country's economy. Likewise, Irish investors, which were very active in 2005, 2006, and 2007 as high-leverage buyers, have been pushed out of the market by the credit crunch.

However, Germany's  open-ended funds are flush with capital, while high-net worth individuals and sovereign wealth funds from the Middle East are actively seeking investments.
Similarly, investors from Japan are aggressively seeking deals, Collins says.

On-going pricing correction
Across Europe, mature markets are at least halfway through the pricing correction, according to David Hutchings, head of research for Cushman & Wakefield EMEA. The change in property pricing globally has broadly followed a west to east drift starting in the U.S. and UK and spreading through Eastern Europe, the Middle East and now most of Asia. In Europe, retail and industrial have taken share from the less favored office sector. 

Cushman & Wakefield says Europe has been most affected by the global repricing of commercial real estate. Values across the continent have already fallen by as much as 40 percent in some markets from their peak in summer 2007. Experts question whether there will be more value erosion this year. Recent data indicates that property yields across Europe have increased 100 to 200 basis points.

"I'm inclined to say it's more of a market correction instead of devaluation, based on the fact that the markets were so active and needed to be reevaluated," Huitikka says.

Hutchings predicts the countries that fell first will be the first to recover. The UK market, for example, is likely to be favored in 2009, while demand will likely increase in France and Germany later this year.

Wilcox of Savills says the UK market clearly generating the most interest and the most activity, primarily because of the re-pricing. The weakness of the Sterling is adding to the market’s attractiveness for foreign investors.

"There is substantial interest from international and domestic buyers in London and the UK as a whole," Wilcox notes, adding that London was one of the first and hardest-hit global property markets. Recent London commercial property trades report 8 percent to 9 percent yields with IRRs ranging from the mid-to-upper teens.

"Across Europe, there has been a flight to quality and strong property fundamentals," Wilcox concludes. "There's a definite focus on mature liquid markets in Western Europe at the expense of secondary and emerging markets across the continent."

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