Emerging Trends in Real Estate® Europe 2006 - Urban Land Institute

Exhibit 2-3
Change in Availability of Equity Capital
for Real Estate by Source Location
Middle East
United States
United Kingdom
Asia
Spain
Other European
Countries
France
Australia
Germany
Netherlands
Italy
■ 2006 ■ 2005
6.60
6.56
6.53
6.46
6.47
6.68
6.47
6.2
6.4
6.65
6.25
6.07
6.1
6.18
6.07
6.08
6.02
5.56
5.96
5.96
5.81
5.83
0.0
1
4.5
5
9.0
9
Very Large Same Very Large
Decline Increase
Source: Emerging Trends in Real Estate Europe 2006 survey.
public confidence in the sector. Changes are also being proposed
by the fund management industry body, the BVI, in
hopes this will stem the outflows that are threatening to spiral
out of control. The outlook is so uncertain at the time of
writing that no one knows whether this will be a short-lived
scare or the onset of a contagion that will force many more
funds to freeze.
Massive redemptions from those funds with significant exposure
to the German real estate market started in December 2003
and escalated well into 2005. However, during the course of last
year it appeared that the funds had restored public confidence
sufficiently to contain the worst of the damage. Parent institutions
of troubled funds had been purchasing fund units and
buying assets from the fund portfolios at book value in order to
reliquefy their offspring. Like the participants in the best-known
example of game theory, “the prisoners’ dilemma,” these parent
firms realised that if they all supported their funds until the
German market picked up, they could potentially find an
orderly way out of difficulty. Then, one parent bank broke
ranks and refused to support their fund—indeed, they took
the unprecedented step of freezing it—and the fragile, hardwon
confidence of the public was sent into a tailspin. A
month later, two more funds were frozen. The problems that
underlie the mass redemptions from the latter were corporate
governance– rather than performance-related. Nevertheless,
there is an escalating feeling of panic seizing the entire openended
fund market.
German assets dominate the portfolios of the largest and
oldest open-ended funds. These “historic big battleships from
the 1960s” own some “old and not very structurally sound
stuff” as well as the impressive new assets that take pride of
place in their annual reports. Their allocations are heavily
weighted towards offices, and book values are well in excess
of market values in some cases. This is partly because of the
characteristics of the officially mandated method for valuing
fund assets (described in our 2005 edition of Emerging Trends)
but also partially due to the ill-judged use of that valuation
methodology. The book values rely on assumptions about
future rents and occupancy, and the optimistic estimates for
these factors used by some funds’ valuers have led to systematic
overvaluation of German offices for the past several years.
“The problem is epidemic. You can’t take a few assets out of a
fund and solve it.”
The difference between market and book valuations of
German office assets in some open-ended funds is purported
to range between 10 and 30 percent. The bank that first
decided to freeze its fund did so in front of a revaluation that
could take up to one-sixth off of its total value, according to
news reports. And the current reductions may not be the end
of the story. A lot of older secondary office space is overrented
and now being abandoned in favour of new prime
office space at cheaper rents with long rent-free periods.
“Who is going to lease this tired old space in a stagnant economy
with a shrinking workforce?” “A lot of the secondary
office will never be relet.”
Revelations about the valuation of fund assets are destined
to change the way they are overseen and possibly the frequency
with which they are done. It is also likely to lead to
more external regulation of the open-ended fund industry.
However, some are questioning whether the industry has a
future, particularly if a successful G-REIT structure is introduced.
“Open-ended funds are flawed in their present form.
It’s illogical to have a liquid fund based on illiquid assets.”
“The REIT is a far more joined-up financial concept and it
will replace open-ended funds.” Some open-ended fund managers
are already planning to float G-REITs when they are
Emerging Trends in Real Estate ® Europe 2006 17