The European Central Bank’s ongoing policy of maintaining low interest rates has led to money flowing freely – and real estate prices skyrocketing. ECB President Mario Draghi probably sees the risk that a tightening of monetary policy could cause – potentially throttling the sputtering economic engine in the European Union’s countries in crisis, such as Italy. Pressure on the ECB is growing, but it’s likely that Mario Draghi won’t want to exacerbate the political situation in Italy. Yet, Italy’s potential new elections in September should pave the way for the ECB to prepare capital markets in the fourth quarter of 2017 for new interest rate policies in 2018 and signal an end to its extremely low interest rate policy.
This change in policy, if it happens, and indeed any interest rate change, poses new challenges to those in finance, in particular, to real estate investors — although PATRIZIA has a number of provisions in place which go some way towards mitigating the impact. After all, increasing interest rates are likely to be preceded by noticeably higher capital market returns but also higher mortgage interest rates. On bond markets, the interest rate spread between the US dollar and Euro bonds of the same rating and maturity is about 200 basis points. Yet increased mortgage rates will not only make real estate investments more expensive to finance – if the returns of real estate investments have to stay en par with the returns an investment on the capital market would achieve, real estate investments need to create additional added value. Without this, it will be difficult to achieve or exceed the kind of returns investors expect, as PATRIZIA has repeatedly succeeded in doing in recent years.
This will remain a challenge in coming years without the active management of real estate assets – even if good local contacts help facilitate lucrative off-market deals that avoid prolonged and costly requests for proposals or bidding processes. However, real estate companies might be able to counteract the rising interest rate costs through appropriate managerial actions or an institutionalised process – the asset management cycle – to give investors the return they demand.
What exactly is active asset management?
Active asset management emphasizes the strategic function of managing assets in real estate funds. Contrary to a more traditional asset management approach, which means to passively hold an asset over the agreed investment period in order to sell it at the end of the term, active asset management includes the constant monitoring and adjustment of the asset performance with respect to the funds strategy. The critical thing is not only to review performance of previous years but also to forecast and budget prospective developments. Drafting different scenarios by adjusting key factors, regarding the asset itself and the market conditions, enables the asset manager to identify the best asset strategy.
“Too often asset managers only look back instead of looking forward.”
Erik Beets, Group Head of Asset Management PATRIZIA Netherlands
What’s especially important here is the use of qualitative and quantitative indicators that allow conclusions to be drawn about future developments, instead of just considering past performance. Erik Beets, Group Head of Asset Management at PATRIZIA Netherlands, sums it up this way: “Too often asset managers only look back instead of looking forward.” The aim of such an analysis is to identify the asset tactic that leads to the best possible performance for the investor. Additionally, the iterative performance revision increases awareness of the impact of external factors and market changes on asset level and portfolio performance.
Successful active asset management
An important determinant of successful active asset management is a preparation of reliable and accurate budget – of course, learning from the past to predict the future. A budget that’s too ambitious or too conservative, for example, can quickly generate an inaccurate perception of performance, which in turn can lead to the wrong decisions. Another requirement is the availability of accurate valuations. As a starting point of the analysis, accuracy is of major importance here and can determine whether results are distorted or not.
Of course, the budget changes throughout the lifecycle of a property. The idea behind the implementation of an asset management cycle is to bring the fund manager, asset manager, and other participants together behind the issues and objectives that are relevant to managing the property each year. During the due diligence phase prior to a deal, it quickly becomes clear which matters must be taken care of immediately after the purchase in order to fulfil the business plan. Once that has happened, the question is whether to sell the property or keep it in the portfolio. If the latter is chosen, the managers must plan the next activities, set up a budget, monitor performance, and adjust the asset strategy to meet the initial business plan.
In practice, PATRIZIA has implemented the asset management cycle in two residential portfolios. This includes identifying actions to improve the asset performance – for instance, by break up sales of individual apartment rights. Asset quality can be improved by developing sustainability projects and making the overall portfolio more sustainable, for example, by attaining better energy labels.
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