ULI UK’s sixth annual Fund Managers’ Workshop saw an audience of 73 members and guests get a pan-European perspective from a panel of leading fund managers and advisers with expertise in both debt and equity capital markets.

The workshop took place against a complex trading and investment backdrop. The macro economic outlook is improving and European real estate remains the target of huge capital flows. Yet while panellists hailed the overall “positive sentiment” from investors towards the sector they also expressed “real concerns over markets overheating”.

The discussion revolved around the opportunities and challenges facing fund managers in Europe today – described as both a “seller’s market” but also a “yield hungry market”. In other words institutional investors continue to favour the income characteristics of real estate – still attractive and stable compared with other asset classes.

Reflecting the mixed outlook, one panellist commented: “Last year we were still talking about whether the challenging times were going to continue. Now, we’re hearing, we’ve recovered quickly, perhaps too quickly, with managers talking about real caution and [about] it becoming a seller’s market. Europe has been fully rediscovered; the question is has the American game played out for investments? So, lots of money is being raised to go after perceived opportunities in Europe, whether that’s Spain, Italy, Greece. There are massive capital flows coming over here to invest, looking for higher returns.”

He added: “It is interesting, still to this day, 70 to 80 per cent of capital that goes into opportunistic real estate funds usually comes from North American sources but it’s very Darwinian. What we’re seeing is that the best have not much of a problem raising money and folks that might have been in business for 10 or 15 years but had a bad fund may be out of business and finding it very difficult to continue to raise money.”

Here are the key questions put to the panellists, and their responses:

Q: What is the business environment like right now for fund managers and should global investors continue to invest in European real estate?

 A: “There are a lot more funds out there who will pay 100 percent cash, whether it’s for portfolios or individual properties, and then will go and refinance afterwards. They will take the financing risk post the deal. There is a lot more positive sentiment in the market, a lot more finance, a lot more improvement in the economy, and there’s a lot more regulation – all of which is driving the opportunities.”

A: “There’s a much more stable and improving environment in Europe. You have liquidity increase, commodity prices going down and the weaker euro. All these factors are helping bolster growth and create a much more positive market environment. Average [economic] growth is about 2 percent. It’s not high but it is positive territory. So over the last two years you’ve got the continuing of a positive sentiment in the market. What’s driving the opportunity is that there’s been a lot of change in regulation.

“How many banks will de-lever and sell their problem assets, no-one knows. But there is an opportunity there and there will be divestments by the institutions and that will create that positive momentum.”

A: “There is an opportunity with the NPL [non-performing loan] portfolios. A year ago, banks had about €360bn worth of assets in their portfolio. They have only divested €100bn so there’s still €260bn of assets within the bad banks that still have to be dealt with. That creates a huge opportunity. Not all of that will transact but even if a portion of that transacts it still represents an opportunity – whether it’s on a loan portfolio basis or an individual asset basis – for investing in Europe. And that’s what the US investors are seeing.

“They’re seeing that positive market environment; they’re seeing increased regulation of banks, effectively being driven to sort out their issues. They’ve got a large base of problem assets that are going to be sorted out and if there is just a portion of those that sell, there’s still a significant opportunity.”

A: “The headlines are of scary yields in London and Frankfurt but if you dig not too far beneath that, there’s still a lot of opportunity in Europe, for the value-add players particularly. Last year we did a lot of work with Germany insurers who wanted 4 per cent, and real estate ticks the box. So a 4.5 per cent Victoria office building is maybe not so stupid, if you can hold it for as long as you like and if you choose your exit moment.”

Q: There has been a lot of money raised for real estate debt vehicles … why now?

A: “We continue to see a lot of opportunity across the real estate sector in Europe. I can’t tell you which phase of the cycle we’re in right now but you’ve got to be cautious on your exits. If you’re a five-year, value-add investor or opportunistic investor and you’re buying portfolios at 7-8 per cent and hoping to get 18 percent then you’ve got to be very cautious. But we’re very focused on growing a significant platform in the debt space in Europe because it is a structural change in the market in our view. To succeed you need to marry capital markets expertise with real estate expertise.”

Q: Southern European markets, such as Spain and Italy, have been the subject of a lot of global investor interest over the past two years. What is the outlook now?

A: “They have pension funds and high net worth individuals that are very active and are pressing down the yields. I don’t disregard the opportunity there but I think it’s going to be limited. Certainly from my experience, it’s about niches and you will have to deal with a lot of local competition with quite a lot of money.”

Q: Previous ULI fund manager workshops have debated the demise of the closed-end fund and how institutions want to join clubs with like-minded investors. Is there a preference now for the structure in which institutions invest? Is there an opportunity for an emerging manager?

A: “Will the closed-end fund market be alive in five years? Slowly but surely the choices are reducing as the competition for placing money into vehicles continues. Some of the big institutions, the big sovereign wealth funds, will continue to joint venture but even here there is a huge amount of competition. And some of these funds are now going back to placing money with the likes of Blackstone as a bedrock investment. But some still want to place big bets with the big managers. The best of those funds will continue to be successful. For the rest of the closed-end space, it will depend on the squeezing of the choices that some of the institutions out there have got but also it will depend on the quality and track record of the manager. For the moment, there is enough choice out there for the institutions, who want to put money into, say, European value-add, to pick an investment manager who will have the best track record. That [choice] will slowly erode.

“A lot of the last five years have been about unravelling some of the mistakes built into some of these fund structures, some of the things we just didn’t see as issues – the misalignment of interests. I think most of the wrinkles have been ironed out so hopefully some of the problems that have scared investors over the last five, six years with closed-end funds are unlikely to occur again. Marrying institutions with like-minded investors is the absolute ideal but you can’t always get what you want in this world when there is less choice.”

A: “There are opportunities for first-time managers if they’ve got good experience. The world needs more capacity for real estate investment and I think you’ll see some of the first-time managers come through and there will be more capacity, if they’ve got their story right.”

Q: Can new fund managers deal with the cost of meeting new regulations?

A: “The AIFMD (Alternative Investment Fund Managers Directive) is only now bedding in. There are lots of people out there who have not clocked what the AIFMD means for them. There will be more regulation. There will be an AIFMD 2, 3, 4, I’m sure. For aspiring fund mangers setting up n business, it will be a cost.”

Q: What is different about the business environment and the market now compared with 2006?

A: “Looking at the lending market, I’m not nervous about what’s going on in the UK because the banks are being pretty disciplined up to 65, 70 percent loan-to-value. They’re killing themselves on price but they’ve got very cheap deposits. What worries me is Germany. I looked at something in the secondary Frankfurt market – a 1970s era office tower, 50 percent let. A well known German bank came along and gave 80 percent of the cost of purchase and offered to finance 100 percent of the cost to re-position the asset. This was an old building in a tertiary sub-market and they were pricing this like it’s a core asset. I look at Germany and I just think all logic has gone out of that market.

“One reason I am more positive now is that the markets that have come back to normalised liquidity – like the UK, Ireland and increasingly Spain – it’s because they’ve cleaned up their banking problems. But I’d be very nervous over the next five years about investing in Germany because of the over-exuberance on cost of capital. So far, except in Germany, it’s very different this time. There’s more discipline, particularly in the UK banking sector, than there was before. But the one market that looks like something pre-crash is Germany.”

A: “The danger now is that people start either going up the risk curve without understanding the risk or paying for growth that might not come through. That’s the similarity to 2006/07, which we’re beginning to see again and that’s where the mistakes will probably come from.”

A: “There is a lot more discipline, whether it’s from an equity or debt lending perspective. A lot of lessons have been learned since 2006/07 and they have been heeded and applied by managers and lenders. Saying that, there’s still a level of craziness out there in some shape or form, whether it’s 95 percent lending on a developer in a German market or closing on a €500m deal with no debt and then hoping you’ll get 70, 80 percent debt at a later date. But if you look at the UK market today there is still limited new supply, which is positive for the market and helping the recovery. So, there are positives and negatives but overall it’s survival of the fittest.”

Words by Doug Morrison

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