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

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“The previous trend was public to private. The new trend will be private to public.” Some do not take them very seriously. “The guys I’ve seen don’t know what they’re doing.” “They’re not a danger— more of a pest. They get into companies when there are rumours, but they don’t do hands-on real estate.” “They’re irritating because they drive prices up.” Others are respectful. “Hedge funds are hiring some experienced real estate professionals and they are moving into our space.” Whatever the opinion of their skills, if they stick around, they will add to the pressure on real estate prices by sheer virtue of their financial clout. They will also add depth to the mezzanine market, where their skill sets in fixed-income investment meet real estate. Institutions and Private Vehicles: Asset Starved According to a number of studies done in recent years, European pension funds are woefully underweight in real estate. Asset/ liability modelling exercises tend to indicate that they should be holding between 10 and 15 percent of their portfolios in real estate, depending on the maturity of the fund. Yet, the most recent figures available indicate the average weighting of real estate in European pension funds is still only around 6.5 percent. They are now trying to close this gap, but the sums involved are formidable. Several of those we interviewed admitted, “Just trying to reinvest our cash flows and dividends is difficult—we’re behind.” Real estate allocations may be higher, but the money has not made it into the market yet. Exhibit 2-4 Euro (billions) 300 250 200 150 100 50 0 Private Property Vehicles by Type of Fund: 1995–2005 ■ German Open-Ended ■ Opportunity ■ Value-Added ■ Core 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Sources: Investors in Non-listed Real Estate Vehicles (INREV), Investment Property Databank (IPD), November 2005. 20 Emerging Trends in Real Estate ® Europe 2006 Exhibit 2-5 Private Property Vehicles by Target Country and Type of Fund: 1995–2005 United Kingdom France Germany Italy Netherlands Spain Other Portugal Belgium Switzerland Czech Republic Poland Hungary Austria Luxembourg Sweden Finland Greece ■ Multicountry Funds ■ Single-Country Funds 0 30 60 90 120 150 Sources: Investors in Non-listed Real Estate Vehicles (INREV), Investment Property Databank (IPD), November 2005. According to studies done by a number of different sources (which are nicely summarised in the CB Richard Ellis report The Pensions Crisis and the European Property Market), a reweighting of current European pension fund allocations to the recommended 10 to 15 percent level in real estate would require between €150 billion and €350 billion in real estate acquisitions. In a European market with an estimated total annual turnover of only €105 billion in 2005, this is an impossible task to do in short order. There would be formidable problems even achieving this reallocation in global real estate markets. The problem will be exacerbated if governments move to funded pension schemes, as this would require additional real estate investment of between €15 billion and €45 billion per annum.
Exhibit 2-6 Gross Asset Value (GAV) in Billions € 25 20 15 10 5 Private Property Vehicles in Europe by Termination Year and Fund Type ■ Core ■ Value-Added ■ Opportunity 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: Investors in Non-listed Real Estate Vehicles (INREV), Investment Property Databank (IPD), November 2005. Note: From 2007 to 2012, 167 funds with GAV €76 billion are planned to end. Pension funds and their advisory consultants are trying to negotiate this minefield, but there is obviously a limit to what they can acquire, even in the medium term. There is also a fear that the objective of providing pensions for an ageing population will be negated by everyone trying to pile into real estate at the same time, with a resultant distortion in pricing. To some extent, this cannot be avoided because there are investment deadlines to be met and the returns on cash are miserable. Clearly, more assets are needed because there is a structural shortage of institutional-quality real estate. Some of those we interviewed from outside the pension industry optimistically stated that “more product will come on the market soon, because the scheduled liquidation of closed-end private vehicles between 2007 and 2011 will release huge amounts of assets.” But the majority of investors in these closed-end vehicles are none other than the institutions themselves. This means that these institutions will have the additional headache of getting the money released by the funds back into the market. For this reason, open-ended funds with no end date are becoming more popular as noted earlier in this report. Publicly Listed Real Estate: High Hopes for the Future The listed real estate sector slightly underperformed the broader European equity market but still turned in a robust performance in 2005. The EPRA Europe index served up an ample total return of 26.1 percent, while the FTSE Europe total return index notched up a 27.7 percent increase. The continued support was quite an achievement for a sector that is normally abandoned when the broader market is strong. The returns were driven by hefty increases in the French market’s premium to net asset value (NAV) as investors hopped onto the SIIC (French REIT) bandwagon. The Spanish market benefited too as another major Spanish listed company acquired semi–tax transparent status by acquiring nearly 70 percent of the largest French SIIC. The U.K. market lagged its continental counterparts, but it benefited from anticipa- Exhibit 2-7 Value (Rebased to 100) 250 225 200 175 150 125 100 75 50 12/31/02 EPRA Europe Return Index vs. FTSE Europe Return Index 6/30/03 EPRA Europe Return Index FTSE Europe Return Index 12/31/03 6/30/04 12/31/04 6/30/05 Sources: European Public Real Estate Association (EPRA) Europe Index, a European publicly traded real estate return index and FTSE. Note: Returns rebased to 100 (beginning December 31, 2001). 12/30/05 tion of future REIT status. The U.K.’s discount to NAV narrowed to the point where it no longer exists if adjustments are made for tax treatment. All markets (except Germany) benefited from yield shift in the underlying assets. A Mercers survey of 157 investment management firms worldwide with US$20 trillion under management shows that expectations for equity performance this year are modest in comparison with last year. However, our own survey indicates that listed real estate in Europe will receive continued firm support in 2006. There is significant growth expected in dedicated global listed real estate funds and this sector was already around US$14 billion in size at the end of last year, according to UBS. There is also growth in retail investor interest everywhere and, of course, European institutions have huge sums to put into listed real estate, particularly if more tax-transparent vehicles become available. REITs behave somewhat like direct real estate and have a fairly low correlation with the broader equity market, so they are used somewhat interchangeably with direct investments by some institutions. The problem for European listed real estate is that Emerging Trends in Real Estate ® Europe 2006 21
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