Fund managers seek real estate in Europe

Copyright: David Lawson – Financial Times June  2001

Home Page

Pension funds have been likened to grizzly bears: immensely powerful but so slow and short-sighted that the juiciest prey escapes their lumbering gait.  But why should they care when there is plenty to eat with easy reach?  Local foraging is  becoming increasingly difficult, however, particularly for real estate.  Fund managers are finally beginning to look further afield.

  Some have been doing this for years. The Dutch economy is too small to support its giant funds while the Germans suffer low yields at home, so both have gobbled up  large swathes of European business centres.   Now they are beginning to face  competition from the US and UK.

  North American funds rarely buy foreign real estate because they have so much at home  but they face a double-whammy from the rise and fall of their economy. Soaring equity values  distorted risk profiles by leaving real estate at less than 4 per cent of portfolios. ‘US institutions are hugely underweight in property,’ says John Carafiell, a managing director at Morgan Stanley. His bank’s chief analyst has recommended increasing the proportion to around 15 per cent  within three to five years.

  That represents billions of dollars worth of property, which  is not easy. New development has slowed, he told the British Council for Offices conference, which was held in Berlin this year in response to the growing importance of cross-border investment flows. Rental growth has also slowed, as US markets peak.

  European economies are less stressed, rents are rising and  vacancy rates are lower. Supply is also expected to boom as  governments and companies  accelerate asset sales. Jonathan Short, chief executive of PRICOA Property Private Equity, a subsidiary of Prudential Company of America, points out that 80 per cent of European property is owned by corporates compared with 30 per cent in the US.

  Institutions are reluctant to consider making direct investments so far from home, however, which is why they are showing increasing interest in a jostling crowd of  opportunity funds set up by big names like Morgan Stanley, PRICOA, Goldman Sachs, Tishman Speyer and Lehman over the last five years. Initially these funds chased opportunities for big private investors, pouring around $10bn into areas ranging from distressed debt to corporate and  portfolio purchases. As institutional investors jump on this bandwagon, the figures could more than double. Morgan Stanley estimates that up to $25bn is targeted at Europe

   Strategies vary to reflect the demands of different kinds of investors. Prudential Company of America [PRICOA], for instance, runs a private equity arm which has placed 500m Euro in higher-risk projects to achieve internal rates of return [IRR] of 20 per cent or more. But this is dwarfed by the 4bn Euro invested in 12 property funds aimed at institutional investors with a lower-risk profile and an IRR target of 14 per cent.

   This proliferation of new vehicles is not confined to US players. Commerz Grundbesitz Investment [CGI], one of the top three open-ended German funds, has developed or bought  almost 4bn Euro of real estate across Europe for small private investors. But CGI head Arnold de Haan surprised the BCO conference by announcing that the group had been enticed by institutional demand to widen its remit. A new fund targeting these transatlantic investors has already raised DM1bn.

   UK players are also joining the fray.  Royal Bank of Scotland is understood to be organising a £1bn vehicle with a lower risk profile than opportunity funds but better returns than institutions could expect at home. Curzon Global Partners is another recent launch, set up by DTZ Debenham Tie Leung and US fund manager AEW with a target of 500m Euro and predicted returns of 13 per cent.

   Doubts remain, however, whether institutions will move strongly into overseas markets. Only a handful of British players such as Standard Life and Equitable Life are making significant investments in mainland Europe. Stuart Beevor, who controls around £5bn worth of real estate as managing director of Legal & General Property, points out that pension funds need to match investments with assets and most of these will be in their home country.

  The attraction of higher rewards is also questionable: ‘If they can get returns of 10 per cent-plus at home, why look abroad?’ says Gerry Blundell, head of European Investment Strategy for LaSalle Investment Management. Total returns of 20 per cent or more include leverage. Stripping this out reduces the figure to around the UK level.

  That has not prevented LaSalle launching funds aimed at spending around $2bn in Europe, but they tend to focus on US investors.  Even there, the reception may be more muted than a year ago. ‘Opportunities are improving at home,’ says PRICOA’s Jonathan Short. He has already seen a move away from riskier schemes and more careful choice of property managers.

  Some insiders are even more sceptical. ‘This is not a fundamental change by institutions but a short-term punt to make premium profits,’ said one Wall Street analyst. ‘They will be out again in five years when markets change.’ 

    Nor is there any certainty that they will go home happy. ‘Europeans are just not geared to this kind of short-termism,’  says Jeremy Lewis, chief executive of Amsterdam-listed Eurocommercial Properties, who has spent almost 10 years creating a pan-European portfolio worth almost 950m Euro for Dutch institutional shareholders. He doubts whether some of the target returns boasted by opportunity funds will be met.