London remains global investors’ darling, says LaSalle
London remains the most prominent location for overseas investors buying into the European property market, according to LaSalle Investment Management’s Mid-Year 2013 Global Real Estate Markets update, but higher return strategies are expected to gain more interest.
The findings show that with the economic backdrop remaining weak across many parts of the Continent capital flows are focused almost exclusively on prime assets with the UK capital the main beneficiary.
Non-domestic investors are contributing to these rising capital flows and their focus is almost exclusively on the major gateway cities of Europe. LaSalle’s mid-year report recommends a set of strategies that can deliver superior risk-adjusted returns to those implied by the current pricing of super-prime properties.
Mahdi Mokrane, LaSalle Investment Management’s head of research & strategy, says: “Just four markets, the UK, Germany, France and the Nordics, attract 80 per cent of the regional volume. In fact, London accounts for 80 per cent of all Chinese property investment in Europe over the past five years, and so far this year Europe has been the largest contributor to Chinese cross-border investments.
“Given its rental growth prospects, London will retain its top position, but we think this phenomenon has compressed prime yields to a level that will accelerate the rotation of capital, and that there is now a stronger case for higher return strategies in the region.”
LaSalle’s Mid-Year 2013 update also found that the UK and Germany are now the most attractive markets in Europe for real estate investors in both high yield and mezzanine debt. “But in this higher return space high quality real estate underwriting experience is required and only a handful of players have that advantage,” says Mokrane.
This is because there is dislocation among Europe’s banks due to overly-extended balance sheets and regulatory changes which has caused most of them to retrench and concentrate on senior lending on high quality assets in their domestic markets. New sources of capital have also mainly focused on senior lending in core markets.
The focus of most investors on low risk assets has caused the yield gap between prime and secondary property to widen in the region, but particularly in the UK where the gap has reached levels last seen in the early 1980s.
“This yield gap reflects in part challenging leasing environments, but we believe that investors are generally more than compensated by the pricing differential witnessed today,” says Mokrane. “Moreover a significant portion of the available stock has been seriously under-managed by its current owner.
“Our experience is that even with secondary retail, occupancy can be quickly improved as long as the asset meets a basic need within its local market. Unleveraged returns of 10 per cent are achievable but debt finance is unlikely to be available.”
Despite a downgraded short term economic outlook for the Eurozone bond markets have not gone back to post 2008 risk aversion mode and capital markets are surprisingly strong.
As confidence gradually increases in the European Central Bank strategies focused on the ability to secure trophy assets at distressed prices in crisis countries will become increasingly attractive. LaSalle’s research outlines that these opportunities will not be plentiful and investors should be highly selective in the markets and assets they pursue. Moreover considerable patience will be required as many vendors’ price expectations are still much higher than buyers should offer.
Global real estate markets continued to improve gradually in the first half of 2013, varying greatly from country to country, while capital markets, by contrast, have recovered quickly and in some countries, have pushed pricing back to or above pre-crisis peaks, according to LaSalle’s Mid-Year 2013 Investment Strategy Annual (ISA).
The recent rise in interest rates in the US, the UK, Germany and Japan signals an important inflection point for real estate investors. Price pressure will ease as debt costs rise by 50 to 100 basis points in these countries. .
The big change is that capital markets are starting to anticipate a “regime shift”– where QE is reduced, and other macro indicators like unemployment and capacity utilization are gradually returning to healthier levels.
Private equity real estate markets can be expected to cool in the months ahead, as the flow of capital fuelled by cheap debt and REIT stock issuance slows.
The report identifies two macro trends – improving economies/fundamentals and rising bond yields and notes that if they remain generally in sync, real estate will perform well relative to other asset classes, especially fixed income. Problems will arise if rising bond yields get too far ahead of an improvement in fundamentals or the growth path of net operating income.
Jacques Gordon, global head of research and strategy, LaSalle Investment Management, says: “With so much volatility in the stock and bond markets, real estate is currently a relatively stable investment. Increases in real estate pricing have been breathtaking this year, and many trophy properties are fully valued in gateway markets. But globally, we see a great deal of future value in logistics, retail and edge-of-core properties.”
The report also sees value for investors in targeting other overlooked sectors around the world, including European senior-mezzanine debt, and retail centres that successfully compete with or complement e-commerce alternatives.