Lessons learnt: 10 years on from the global financial crisis
Real estate was one of the contributors to the global financial crisis that began in 2008. Ten years on, it's time to reflect: Charles Tarrière, fund manager for the PATRIZIA TransEuropean funds, discusses lessons learnt and how PATRIZIA weathered the storm.
Do you think real estate is still a big risk to the global economy?
Personally, no. Real estate was not the trigger of the GFC: it was debt-led, and while real estate was affected, it struck many other sectors too. Today, real estate is still part of investors’ portfolios. It has shown its resilience and will continue to feature prominently in portfolios, among other reasons because of the income component. The pricing compared to the interest rate of bonds is very attractive.
Will there be another crisis?
I’m sure there will be. It’s the nature of capitalism that one crisis follows another. Will it be as big as the last one? Probably not. Will it be a crash or the slowing down of global growth, linked to tension on the political scene, less demand from China or for other reasons? No one knows. But the risk is still there – just think about overpriced technology companies such as Airbnb or WeWork who are still making massive losses. But on the retail side, companies such as Sears have disappeared after 140 years in existence. They were essentially the inventor of catalogue trading in the United States and have been killed by Amazon because they weren’t able to compete with the trend. But humans still need to live somewhere, work somewhere, have fun somewhere. Real estate is at the very heart of our economies, however digital they become.
What are your main lessons learnt from the GFC?
Before the GFC, many of us, me included, were tempted by high yields, forgetting about the inherent risk of the property. The first thing I learnt was: Don’t chase high yield – look at the fundamentals – what makes a property sustainable? Maybe its use today isn’t ideal. But if it has a purpose in the future, it will have occupier interest – meaning rent. An example: We bought some car showrooms in the Netherlands just before the crisis. The high yield drove us. Our plan was to convert these showrooms into retail. But we failed to look into the occupier covenant – which collapsed during the crisis. We ended up with a portfolio of four car showrooms that were completely empty. Automotive was an industry that was hit heavily by the crisis. We realised that the location and type of property made them redundant for both present and future use.
One of the four properties was located in downtown Rotterdam. We converted it into a car park because of its location – it was the only property that we didn’t lose money on. This shows that we should have concentrated more on the occupational question than the financial aspect. You need to pick your stock carefully.
Another lesson is to stay close to the client. Even if things go wrong, keep communicating. We visited a client in Texas about two weeks after the collapse of Lehman Brothers. It just so happened that we showed up there after the big news. One of the directors came in and said: Guys, I don’t have much time for you, but I want to thank you for showing up, for offering solutions because I’m sure a number of things have gone wrong. This is a global investor that has invested with us since 1992, and, ten years on, invested in three more of our TransEuropeans. That is what I mean with staying close to your investors. We won a lot of credibility points at that time. It has to be in our DNA, if things go wrong, we need to face reality.
The third lesson is to stick with what you said you would do – don’t go off-piste. Be flexible, obviously, because markets change over time. TransEuropean is a cross-country, cross-sector value add fund, so we have the flexibility to invest in a number of countries and sectors. But when we say we’ll buy commercial real estate in core Europe, for example, and then end up buying senior housing in Russia, the investor won’t trust us anymore, and rightfully so. I have heard stories of people in the business who did almost the opposite of what they promised their investor and they have, as a result, been dumped by those same investors.
Our business is based on the satisfaction of our investors and if we mess up, it is difficult to recover. We need to make sure that we deliver a good performance and a good service to our investors at all times. It is easy when the market is going well, and everybody is making money. During the bad years, you can see what the manager is made of – how they deal with difficult situations and learn from their mistakes.
How was your investment style more suited to weathering the crisis than others?
Generally, we were seen as a careful, low-leverage investor. With TransEuropean, we have never used too much leverage. That helped us enormously with the last GFC. Some of our competitors had an LTV of 80% or 90%. I even remember seeing acquisitions in countries like Greece with 110 per cent LTV. So, banks were willing to lend more than the value of the property plus additional money to pay for capex. This is great for the manager because then it is the bank’s problem, but I find it absurd to accept such levels. We never leveraged our funds more than 50 per cent, even on a value-add fund. The company has been around for 35 years and the GFC was not the first crisis it had to live through. We had the dotcom bubble, the 1990s crisis, and so on. We knew how destructive debt can be.
You said one strategy is the application of higher risk strategies in the lower risk markets. Does ‘higher risk' still scare people, ten years after the crisis?
Yes, I think it does. But investing is a matter of qualifying and managing risks – this is what investors want us to do. Stick with the risk that you marketed to the investor, don’t double or triple the risk, even if you feel like you know better. For example, if you invest in building that needs refurbishing, in a risky country or city, and then add a high level of debt – maybe in a non-fund based currency (e.g. fund is in euro and you start buying into Swedish krona), you will find yourself with a multi-layer risk. That is not what you should be doing; your mandate is to take appropriate risk. When we set up TransEuropean funds, we take property risk. Adding extensive and therefore inappropriate currency risk, leverage risk or macroeconomic risk, for us, is out of the question.
How would you argue PATRIZIA’s survivability since the crisis?
We place enormous importance on research. We used to be property people that were deal-led, now we focus on the bigger picture: Where is a country/city going, what are the main trends, what are the fundamentals? The inclusion of research in all our investment thinking is critical. A city like Amsterdam will not evolve the same way as Paris or Helsinki.
Another lesson learnt is that we should focus on districts. You need to ‘select the winning districts in the winning cities’. We invested in Berlin, for example, following two years of in-house research – because the data was not available anywhere else. We sent people to Berlin to study the market, and we selected the areas of Mitte, Kreuzberg, Friedrichshain as places where we wanted to buy offices. Today it seems obvious, back then it wasn’t. Berlin wasn’t in the crosshairs of investors. We’ve seen how rent has doubled/tripled at some of those locations. But four or five years ago, when we conducted this research, we were pioneering an investment style. With the help of the research team we were able to create a database that allows us to invest with our eyes open.
The reason why we started this research was that we missed the equivalent trend in the UK: The market of Shoreditch tripled in rent. We didn’t see it coming because we were unprepared. From Berlin on, we have been prepared for similar projects in Europe. That is why the European market is interesting – there are still a lot of pockets of wealth and value in Europe.
We still face the hangover of the crisis when we talk to clients. Scars remain. But the lessons learnt made us, as a collective, better investors.
We’ve often talked about the lack of available assets: Do you think investors will have to take on more risk in order to find the right asset to invest in?
No, I’m not worried about access to the market. PATRIZIA is in a very comfortable situation with our strength of local expertise. Our competitors rely on inter-agency collaboration and their local JV partners to find deals – deals are brought to them by whoever wants to sell. Of course, we can tap into that if we want, but we have other ways of access. Through our 19 offices in Europe we are able to source deals off-market: For our TransEuropean funds we did what we call PATRIZIA Deal Finder, where we visited districts ourselves. Working with local advisors and our research team, we identified winning districts in the winning cities: maybe 20 streets in key cities that we want to invest in. It’s all about finding these deals and creating an in-house database of properties. These might not be for sale right now, but we know what we would like to buy and which local owners to contact.
Yes, prices are going up and there’s more competition, but I think a lot of our competition is not as inventive as we are in finding off-market deals.
Warren Buffett stated that the 2008 crisis taught us that “we are all dominoes”. Are we still so interconnected? If America goes under, will Europe follow shortly after?
Dominoes don’t all fall right away. It can take a long time before the last domino falls, by which time the first domino might be back up. My view is: If the US suffered a crisis today, it could still take two or three years before it hits Europe, and it may hit differently here. As we’ve seen in the GFC, our economies are not the same. For example, in the mid-2000s, Germany was a very unattractive market. Even German investors were leaving their domestic market, they didn’t believe in their economy or property. Thirteen years on, we know that Germany is the powerhouse of Europe. One reason is that Germans focused on creating fundamentals that helped them grow quickly and strongly. It’s the same for property: If you focus on sound fundamentals – location-wise, build-wise, occupational-wise, you will weather the next crisis.
Photos: Westend 61