WHERE NEXT FOR US INVESTMENT OUTFLOWS AND HOW WILL CAPITAL BE DEPLOYED IN EUROPE?
At an event in late 2015, Jon Gray, the global head of real estate at The Blackstone Group, was asked where he would invest if he had just one dollar left to his name. He said southern Europe.
The world’s largest private equity real estate investment firm has been particularly active in Spanish residential markets after what Gray described as a 40% decline in house prices and a 97% decline in new construction. For him, that market, like a number of others
in the region, is at a later stage in its post-global financial crisis recovery and had plenty of value left to capture.
Blackstone is among the largest stewards of outbound US institutional capital, a fund manager which last year closed a $15.8bn global opportunity fund after closing on $8.8bn for its Europe focused fund in 2014.
While the New York firm raised the most opportunistic capital for European deals, it was by no means the only higher risk and return manager active in the continent’s property markets. Others included Lone Star, Starwood and Cerberus. Core strategy US managers have been busy buyers too, like LaSalle, CBRE Global, TIAA-CREF and Cornerstone. Real Capital Analytics (RCA), the property investment research firm, reckons the €45.3bn of US investment in Europe it recorded in 2014 was just shy of the 2007 peak.
Given the volume of investment demand, 2015 is likely to prove a record-breaking year. But why the greenback-led run on European real estate? At a basic level, the answer is simple.
As the primary market for both domestic and cross-border capital, US investment records have already been reached.
Though not always supported by rental levels, prime capital values have matched and, in many cases, surpassed pre-crisis peaks as an unprecedented wall of capital has competed to be invested in the country’s five gateway markets.
In the first half of 2015 alone, there were $400bn in deals done, RCA says, up from $350bn in the whole of 2014. Accordingly, US prime yields have compressed to uncomfortable lows for a number of investors, prompting the sizeable capitalization of strategies in the next most popular regional market: Europe. Such overcrowding, compounded by the dollar’s recent gains against the Euro (almost $1:€1 at the time of writing) and the expectation that interest rates will rise sooner stateside than in Europe, has led to plenty of investors boarding the European bandwagon.
US institutional capital, by nature of its relative maturity versus its recently deregulated Asian counterpart, which has been keener to transact directly, is demonstrably more discerning about where it is deployed and, crucially, far more willing to invest indirectly via trusted managers. As such, you will not likely find too many US institutions buying shiny new glass offices in central London. You will, on the other hand, regularly read about a US institutionally capitalized fund manager deploying resources into alternative property sectors in gateway cities like London student accommodation or into mainstream asset classes in secondary jurisdictions like offices in Stockholm.
These days, privatisations, such as Lone Star’s acquisition of Quintain Estates are just as likely given US perspectives on stock prices versus net asset values relative to what is available in the private sector.
Track recent reports on US capital deployed into European markets and you will notice something of a geographical pattern. Predictably, the UK was first on the proverbial shopping list, followed by Germany and France. Latterly, however, Italy and the Nordics have attracted scale investments. TIAA CREF’s €4bn joint venture investment with Sweden’s national pension funds last month is testament to the latter.
Concurrently, Spain has witnessed inflows from investors with higher risk tolerance, as has neighbouring Portugal.
Central European markets like Poland are expected to pull investment, relative to historical volumes. Look out for a major loan book sale covering Poland and Czech Republic which is said to be drawing bids from JPMorgan, Lone Star and Oaktree as evidence of that. For the next couple of years at least, expect to see US-fuelled investment volumes continue to rise, particularly via higher risk and returning indirect strategies.
Will this cross-border influx last? By nature of its higher yielding expectation, the volume of US capital buying European real estate likely will depend on relative factors when compared with what is happening stateside and, indeed, in the world’s growth region, Asia.
An increased interest rate in the US might see US institutional investors slow their European real estate programs in favour of less management intensive asset classes. Similarly, should Asia’s current spate of macro volatility abate for a sufficient period of time, ex-US investing strategies might shift. A generalized market correction could also provoke a return to domestic assets as, theoretically, US yields would once more become attractive.
However, PERE held its annual US Summit last month and the prevailing wisdom was that US markets have at least two years before experiencing a correction. If correct, the inference then is European markets have meaningfully longer to run and so a reversal of current US appetite would remain off the table for some time yet.