With mainland Europe enjoying signs of economic recovery while the UK contends with the headwinds caused by Brexit, European real estate investors looking for relative value opportunities have to remain more disciplined than ever to stick to their investment principles.
BlackRock is no exception to this. Speaking with Property Funds World, Thomas Mueller, Managing Director, BlackRock Real Assets and Portfolio Manager for Europe Property Fund IV, says that investment discipline is key.
“What we see in the current market is a tendency to drift a little bit in terms of strategy and style,” says Mueller. “As market conditions become more competitive, it gets harder to originate good transactions. A lot of my work with the investment teams across Europe focuses on how to be strategic around origination. About 70 per cent of deal flow in the fund is off-market.
“We make sure we remain selective within the investment principles we set, which are to focus on the most liquid markets, keep business plans short, take leasing risk, focus on sub-markets experiencing irreversible structural change and never to take binary risks that we can’t control. We don’t compromise on those principles but it requires constant dialogue.”
Europe Property Fund IV closed a year ago with EUR700 million in commitments from more than 30 global institutional investors.
Mueller is responsible for setting the value-added strategy for real estate across European cities and sectors and is actively involved on the investment side of things. So far, he has completed 12 transactions.
BlackRock is quite unique in the way it is structured in the European PE/RE sector.
“When you look at the industry, probably around 80 per cent of our peers are set up as classic allocators with big offices in London and use local operating partners. We’ve deliberately chosen a different approach. In the core markets where we are investing we have a local presence. Our investment management teams are spread out across a number of European offices including London, Paris, Frankfurt, Copenhagen, and over time we will look to broaden that out to include Madrid and Milan,” comments Mueller.
Together with the research teams, who provide top-down data, and the local investment teams, who provide the bottom-up data, Mueller sets the strategy for each market, adding: “I try to support the investment teams as much as I can with origination. Typically, within the strategies we set, they will go and originate and together we bring each deal to the investment committee.”
While it is a truly pan-European fund, in practice the core markets are the UK, France, Germany, the Nordics, Ireland and Spain and Italy, on an opportunistic basis.
In terms of tactical investments, the Fund has been underweight the UK, on a relative basis, and overweight Germany and France. In Germany, Mueller points to four key cities that are attractive from a fundamental perspective: Berlin, Munich, Frankfurt, Hamburg. In France, he says, it’s just Paris: “Beyond that, liquidity drops off. For us, the primary focus is to be in the most liquid cities in Europe.”
As it is a multi-strategy value-add fund, the portfolio is able to invest in offices, retail, logistics, student housing. In the UK, over the last few years within the value-add universe, the Fund has mainly invested in student housing.
Mueller explains: “Early on, in the UK, we took a view that the low beta sectors were more resilient and would likely deliver better risk-adjusted returns in the context of a possible Brexit scenario; this was back in October 2015 before the referendum.
“We didn’t predict Brexit but we deliberately took a view on what the impact on different sectors in the UK would be, were it to happen. On the back of that analysis, we took a conscious decision not to take potential downside risk in the office and retail sector. Instead we went long the student housing sector.”
London is beginning to feel the effects of Brexit. Commercial rents are softening and while there is new stock coming on line, take-up is below the historical average and vacancies are creeping up. In its predecessor fund, BlackRock sold its last office building in the City two weeks before Brexit. Since then, the house view has been to take a ‘wait and see’ approach, on the expectations that there’s a correction on the horizon.
The BlackRock team is constantly on the search for “irreversible structural change” in European cities. Whether that’s structural change with regards to micro locations, such as Crossrail or Grand Paris for example, or sub-markets like Croydon in South London, where obsolete office stock is being converted into residential developments, thereby boosting the office sub-market.
“We are seeing something similar in Frankfurt in the Niederrad sub-market, where we bought an office building back in 2016. Niederrad had double digit vacancy and a bad reputation amongst office tenants until most of the vacant office stock was converted into residential.
“With any analysis, however, you’ve got to be very selective. In some sub-markets, if you find the right location and you can effectively deliver the right product at the right price, then in that context Frankfurt is a very attractive market. But if you look at Frankfurt’s CBD, for example, there’s quite a large supply pipeline, which would suggest rents might not develop as favourably as some people might think,” says Mueller.
Nevertheless, lot of investor capital that was originally heading to the UK is now being allocated to Germany, and Frankfurt is often the first port of call.
In terms of liquidity, the cities that increased the most in 2017 were Dublin, Copenhagen, the four German cities and also Milan and Madrid. Mueller says they are not yet active in those two cities because if the Fund can achieve attractive risk-adjusted returns in core markets, there is no point taking on more risk investing in Madrid or Milan.
As mentioned, the Fund’s investment strategy is to seek out sub-market opportunities where there is a dislocation in terms of supply and demand.
One such city that has proven to be attractive is Dublin. “It was probably up 30 per cent, over the long-term average, in terms of liquidity in 2017,” says Mueller.
The first investment BlackRock made in Dublin was in student housing, precisely because there was a substantial supply/demand imbalance; something like seven students for one bed. In the UK, anything over two students to one bed would be considered an under-supplied market.
“We took a first-mover approach and we are developing from the ground up a new student housing scheme currently in the northern part of the docklands. This will add just shy of 1,000 new beds.,” confirms Mueller.
Not only is this addressing a massive shortage and providing good quality, good value accommodation to students, it is, crucially, regarded as a highly attractive investment opportunity for BlackRock’s investors. New developments only account for 15 to 20 per cent of the Fund. The wider objective is to acquire existing assets that have correctable impairments, are in a good location, and which have the potential to be re-positioned as core assets.
Still, the Dublin student accommodation development is a good example of how BlackRock is committed to ESG investing. Indeed, Mueller confirms that later this year the Fund will be submitted for a GRESB rating.
“For the Fund we signed the first green loan with Lloyds bank. It was the first they had issued. Lloyds gave us attractive pricing for the loan if we complied with various standards. The savings on the interest costs were reinvested into the building – a student block in Hoxton, East London - to make it even more attractive from an ESG perspective,” confirms Mueller in conclusion.
Specifically, BlackRock will benefit from a margin reduction on its loan – covering both development and investment phases by guaranteeing specific ‘Green Covenants’ including a BREEAM Excellent rating, a strong GRESB score and the installation of numerous energy efficiency creating technologies.
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