A new dynamic

Challenging market conditions demand new investment strategies – in particular, the focus is on pan-European real-estate investments. The keys to success are speed and, above all, local expertise.

The European Union is navigating through stormy waters, according to the European Commission’s most recent economic forecast. Brexit, US President Donald Trump and upcoming elections in several large EU countries are all contributing to unusual levels of uncertainty. Nevertheless, Brussels still expects solid economic growth of 1.8 per cent for this year and next. What’s even more remarkable: This is the first time in almost a decade that the European Commission is predicting growth in all member states throughout the entire forecast period, from 2016 to 2018.

Unemployment is expected to fall noticeably: the Eurozone is aiming for an average rate of 9.1 per cent. Last year, the unemployment rate was still in double figures. On the other hand, rising energy prices are expected to cause a jump in inflation: from 0.2 per cent last year to 1.7 per cent in 2017 and 1.4 per cent in 2018.

Despite rising consumer prices, the European Central Bank (ECB) is unlikely to tighten monetary policy at this time. At least, ECB President Mario Draghi has given no indication of wanting to end his quantitative-easing programme – never mind actually raising interest rates as the US Federal Reserve has done. Given that 2017 is the year of European elections, the ECB will presumably not want to risk another banking crisis. So the attractive financing conditions for real-estate investment are not likely to change, but instead will benefit from higher economic growth and falling unemployment.

As it is, demand for commercial real estate in the European market is already extremely high: in Germany, for example, prices for commercial real estate grew faster than those in the residential market in 2016 – for the first time in a long while. According to a study by the Verband deutscher Pfandbriefbanken (an association of German mortgage lenders), office buildings are of particular interest to domestic and foreign institutional investors. Accordingly, their capital value grew by 10.1 per cent compared to the same quarter last year, while rents grew by just 4.3 per cent over the same period.

With such price fluctuation, even industry experts have difficulty finding promising investment properties. When the market dries up, it is necessary to look beyond national borders to fulfil the targets of institutional investors, particularly since, despite all the uncertainty, worthwhile opportunities turn up again and again both at home and abroad. By identifying and capitalising on such opportunities early on, it should still be possible to find lucrative investment properties for customers even in difficult times.

In any case, there’s no reason why a real-estate portfolio made up of properties in different countries and various asset classes should be any riskier than a focussed investment approach. Quite the opposite, in fact: if it is set up correctly, a varied, pan-European concept offers better risk diversification. While that’s hardly a revelation, the idea has been slow to gain acceptance in the market. To make this approach a success, however, the building blocks investment managers work with need to be put together differently.

First building block: the pan-European network

What’s important for a pan-European network is, above all, proven expertise in the continent’s major cities. Jochen Reith, PATRIZIA’s Head of Institutional Clients for the D-A-CH region, is convinced: “Real-estate business is always local. We will only be active in countries where we have experts on the ground, because that is the number one guarantor of our success.”

“On-the-ground local expertise is also crucial in managing our assets, so that we can achieve the retrun we promised investors.”

Jochen Reith, Head of Institutional Clients for the D-A-CH region, PATRIZIA Immobilien AG

As long as the ECB keeps interest rates low, tangible assets are the logical first choice. For the time being, institutional investors’ target returns of at least 4 per cent per annum are scarcely achievable even with the best government bonds. The investment pressure will remain high then, given that many institutional investors are still substantially underinvested in real estate.

Second building block: greater speed

Nonetheless, the European markets, even in Germany, are very heterogeneous: the rental price multipliers and the legal regulations that underlie rent increases vary considerably. That makes the assessment of larger-scale deals abroad extremely time-consuming and costly, although success may appear uncertain for quite some time.

Above all, speed is a decisive factor. Substantial advantages can be gained through a pan-European network and years of experience in markets, particularly as off-market deals grow in importance, where sellers seek to avoid lengthy tendering processes. The one who can close the deal faster than the competition – such as through a “blind pool” solution – has an added advantage.

Here too, speed is of the essence in the closing, since circumstances can quickly change due to political transitions. In addition, rapid shifts in exchange rates may occur occasionally. In 2014/15, the euro lost a quarter of its value against the US dollar. US investors who neglected to secure their euro-denominated capital investments against foreign-exchange losses, suffered considerable losses. The surprising outcome of the Brexit vote in June 2016 resulted in a sharp devaluation of the British pound to the euro.

Of course, real-estate investors are well aware of the risks associated with properties outside the Eurozone. For any number of reasons, however, many clients do not wish to hedge their positions, while for others, the investment manager assumes this responsibility.

Third building block: Europe needs European approaches to assert itself on a global level

Europe’s economy is facing enormous challenges. A trade war looms with the US, whose new president seems willing to use import tariffs, penalty taxes and other abrasive methods to make good on his “America first” election promise. His economic stimulus programmes and tax cuts aimed at creating jobs and promoting growth will not only incur huge costs, they are likely to depress tax revenues. In view of the gigantic national debt of close to 20 trillion dollars, Trump can hardly finance his plans entirely with more debt.

Thus, in addition to imposing burdens on Asian corporations, he will probably extend this “responsibility” to European companies as well. The European Union will lack these funds to solve its own problems unless Brussels puts up a vigorous defence.

Just one example: In many areas, the rapid growth rates in online retail require infrastructure upgrades, yet brick and mortar-based retail is suffering sales losses. Outlets in large urban centres are holding up reasonably well, and thanks to their click-and-collect services even benefit from the online retail boom – including specialty market chains and shopping centres.
Office buildings offer good prospects for investors, since vacancy rates in most urban agglomerations have dropped. The logistics sector still promises the highest rates of return, although they are declining because of great investor demand.

All these facts make a strong case for European commercial real estate. Why? In addition to annual net cash-flow surpluses of around six per cent, they provide an above-average opportunity for positive changes in value, which in recent years had been two to three per cent per annum.

Fourth building block: market experience

Putting your faith in new products, particularly with “blind pool” solutions, means investors need to have a great deal of trust in their investment manager. A strong track record of completed transactions reinforces this trust and rightly generates great interest with investors.

Successfully closing deals and reaching target returns obviously depends on more than just the state of the market and the timing of the purchase. Ultimately, you have to get multiple factors just right: Step one involves getting into a market early enough. But one should not underestimate the importance of step two: Particularly in the value-added area, proper management of real-estate properties is of the utmost importance. Then it should be simple to exceed return targets with the sale.

A prolonged period of low interest rates and dried-up markets is forcing investors to extend their horizons – be it with a pan-European approach to investing or “blind pool” solutions. Bringing these transactions to a successful outcome and securing high returns, however, is only possible through the combination of local expertise and the quick response to opportunities.

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