The Capital Insights debate: Real estate M&A and capital management
M&A and corporate confidence in the real estate sector is on the rise — but challenges lie ahead. EY’s Ad Buisman and Christian Schulz-Wulkow discuss the state of the market with five of the industry’s leading figures
Although uneven economic performance across Europe is painting a complex picture of the industry, real estate M&A in the continent is picking up. In the first three quarters of 2013, it increased to US$63.4b compared with US$54.6b in the same period last year, according to Mergermarket. In addition, confidence in the sector is building. Respondents in EY’s European real estate assets investment trend indicator 2014, which surveyed more than 500 investors across Europe, felt that transaction volumes were set to increase in 2014 and that European countries were viewed as attractive investment destinations.
However, these optimistic figures are tempered with caution. Obstacles such as low growth and continuing instability in the Eurozone still need to be overcome.
AB: EY’s research suggests confidence is building in the real estate sector. Is this justified?
JB: I think the optimism is generally justified. Interest rates have remained at historically lower levels than was ever expected and look set to continue in this vein. Real estate offers better returns than bonds, and so the industry is in a good position to do deals. Here in Germany, we saw an increase in real estate deal value over the previous year. And you’re seeing property values rise in some of Europe’s major cities, such as London. There is a lot of money looking for investment in the sector.
AK: I agree that it’s growing, but I’d argue it’s more a case of cautious optimism and that it varies according to region. In the UK, as each set of quarterly statistics comes out, there are positive attributes. However, in Spain, for example, the sentiment is different. This divergence is quite normal and you have to put it into context: it’s less than two years since Mario Draghi made his statement [to do whatever it takes to support the single currency], and that was a game changer in Europe.
The general consensus is that there won’t be a major bounce, but that growth will be steady and slow. Interest rates look set to remain low for some time yet, and there is a degree of stability in Europe. That helps with business decision-making after a highly volatile period.
OP: I’d agree with both points. But, like Anne, my feeling is more middle of the road. You have two competing forces at work. One is that you still have low or no growth in many European countries and, as a result, you are seeing some weakness in commercial asset rents. This is only just starting to show through because of the long-term nature of leases. That’s why I can’t be an optimist.
Yet what drives me to the middle is that there seems to be an almost infinite amount of capital to invest in real estate. Institutional investors, insurance companies and sovereign wealth funds are all coming to Europe in much the same way as Japanese investors came 25 years ago. This means that, while rents are softening, prices are stabilizing. Some might say the amount of capital going into the market is dangerous. But I’d argue that there is a strong rationale behind it. As Jan said, the low-interest environment means that investors can get yields on government bonds of around 2%, while investment in sound assets like real estate can yield around 5%. The gap between the two is the highest it’s ever been. In addition, real estate provides a hedge against interest rate rises in a way that bonds do not, because rents are usually indexed against inflation.
CC: The real estate market remains attractive. This is especially so for investors because, as the others have mentioned, interest rates remain low and yields are high. There are many opportunities in the real estate market. We at Unibail-Rodamco focus on a specific segment of the market — prime shopping centers in the best European locations and offices in Paris’s Central Business District and La Défense. Even though the current business climate lacks the dynamism we’d like to see, we believe there is still much value to be created in our sector.
CSW: What main challenges does the real estate sector face?
PK: The main challenge in Europe is that the process of deleveraging has not yet been completed satisfactorily. In contrast, debt markets in the US and Asia are functioning better, with higher loan-to-value ratios. The other challenge is the low-growth environment, where there is a polarization between different types of assets. The prime market is best positioned, while in secondary markets, you really have to question whether there is a future for many of the assets built during the boom. This polarization is present in retail — with shopping centers — but also in office space. The challenge for investors is how you run your portfolio and ensure that you make the right selections. Investors are now strengthening their focus on income. Capital growth is important, but income is much more so now.
JB: Yes, I agree that selection is vital in today’s market. Most investors want core real estate. But this is limited, so prices are rising. To be successful, investors need good networks and quick decision-making processes — and they must be able to put money on the table quickly. Those with a good equity position are well placed in this market.
OP: Like Patrick, I think that one of the main risks in the market in Europe is that the economy remains in low-growth mode. As a result, vacancy rates are rising. If we see another two or three years of low growth, higher vacancy rates will soften rents and returns will fall. However, what mitigates this is that most of the assets acquired today are with equity. Investors now have limited appetite for debt. A fall in rents would therefore not be so dramatic, unlike in the past, when leverage was much higher.
CC: The economic turmoil is still impacting the companies’ strategies. Performing retailers are becoming more selective and are looking for outstanding locations with high footfall and large, wealthy catchment areas.
Our main challenge is to stay ahead of the pack, as being a market leader is not a guaranteed position. Among the other issues, the internet is probably the most well known. However, we see this as an opportunity.
The assets that will continue to outperform the market are those that offer a differentiating customer experience, and the internet is an incredible tool that helps you achieve this. It’s a means of communicating directly with our customers and, more importantly, it enables us to understand how to go even further in satisfying the customer.
Lastly, office assets face more difficult times. However, there is still room for well-located, well-connected, user-centric offices. The recent letting of the So Ouest offices tower in Paris to SAP definitely proves this.
At the table
Jan Bettink (JB)
CEO of Berlin Hyp; President of German Mortgage Banks
Christophe Cuvillier (CC)
CEO and Chairman of the Management Board, Unibail-Rodamco
Patrick Kanters (PK)
Managing Director Global Real Estate and Infrastructure, APG
Anne Kavanagh (AK)
Global Head of Asset Management and Transactions, AXA Real Estate
Olivier Piani (OP)
CEO, Allianz Real Estate
Ad Buisman (AB)
Partner, Real Estate Services at EY Netherlands
Christian Schulz-Wulkow (CSW)
Partner, Real Estate Services at EY Germany
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