BRIEFING: Brexit is going to benefit CEE

Some investors are taking a wait-and-see attitude to the UK and will deploy at least part of their capital in the CEE region.

It is still not clear what impact Brexit will have on the UK, but it is clear that it will benefit Central and Eastern Europe, delegates heard at Investment Briefings’ CEE and Europe Outlook panel, which was held in Warsaw lastweek.

‘Is Brexit going to benefit CEE? The answer is yes,’ said Luke Dawson, Managing Director & Head of Capital Markets CEE, Colliers International. It will probably not increase investment volumes by €1 bn, but we will see a few investors come and look that wouldn’t otherwise have come here.’

Some investors are taking a wait-and-see attitude to the UK and will deploy at least part of their capital in the CEE region, where markets have matured and are now more liquid and more attractive.

‘A place like Poland is filling that gap,’ Dawson said. ‘It is something between Western Europe and an emerging market. The returns are pretty attractive but, as our markets continue to mature, investors are also more comfortable with the levels of risk.’

The risks associated with Brexit are also putting political issues in Poland and Hungary in perspective. ‘The political situation in Poland has become less of an issue,’ said Janusz Dzianachowski, Attorney-at-law and Partner, Linklaters. ‘Big investors in our country, like the South Africans, are not very concerned, as they have a very different idea of political risk from ours. Now it is all about Brexit and how we can benefit from it.’ 

There is another, less positive side to Brexit that some investors worry about, said Rainer Nonnengässer, CEO, International Campus: ‘They focus less on the benefits and more on the uncertainty that it will bring and the negative impact on the European economy that could affect the real estate sector as well.’ This worry is particularly acute in Germany, where the economy is already slowing down.

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Huge demand from Asian capital

Asian capital continues to pour into Europe but investors from different countries are after different sectors and products, according to CBRE.

Asian capital continues to pour into Europe but investors from different countries are after different sectors and products, according to CBRE.

‘We have never seen so much capital from so many places coming and looking for product,’ said Stephen Miles, executive director – EMEA investment properties, CBRE. – There is a huge amount of demand from Asian-based capital, driven by currency, spreads and diversification needs.’

All that capital is now firmly focused on Europe as the US market is seen as difficult, he said, but there are many nuances as Asian investors behave in different ways. 

‘South Koreans look for long income and good covenants to underwrite in a safe way, Hong Kong capital is still mainly focused on the UK and is not really spreading into Europe yet, while Singaporeans are focused on value-add and core plus stories, driving value in the capital they are deploying,’ he said.

‘Many markets have been starved of development for a long time, so investors who want good product need to go up the risk curve,’ said Miles. ‘People are re-defining what they think it’s opportunistic.’

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UK & European Real Estate Markets in 2019: Five Big Themes

This morning we present some of the sector and strategy investment calls for 2019 from leading investors, advisors and research teams across Europe.

5. Investment calls

Morgan Stanley (MS) offers three big listed property calls:

  1. Logistics: “We are bullish on logistics property, and we see Segro as an attractive play on that theme.” says MS, adding that return profiles for big-box warehouses and last-mile distribution assets will further delineate in 2019. MS says increased security and visibility of big-box income justifies yield compression, but do not expect rental growth. By comparison, rental growth is likely for last-mile and urban assets for which land scarcity limits supply. “OK to own urban assets, but big box to become a developer market. As such, we think equity markets will no longer reward models that buy and hold ‘dry’ big-box assets.”
  2. German residential: While yields are getting low, MS sees several drivers for continued capital growth: annual rental growth in the region of 1-3% is achievable; resources available among listed universe for capital expenditure to modernise portfolios; significant government stimulus from which could amount to €3.3bn during this coalition’s 4-year term. This home-ownership programme is more attractive than the UK’s ‘Help to Buy’, as it is a grant and it relates to all property purchases (not just to newbuilds). In addition, Germany’s housing demand still significantly outstrips availability and supply, while there are no signs of household mortgage debt issues.
  3. Spain: “We are convinced the outlook for a material part of Spanish property remains compelling.” Office rents are rising while vacancy has been failing and consumer spending is rebounding, says MS, adding: “Most importantly, yields have compressed materially… Spain is still early in the expansionary phase for Spain, a country that tends to experience long economic cycles.” However, to temper slightly, it must be remembered that GDP growth has been moderating while the rising return requirement for US capital – integral to the real estate sector’s revival – offers cause for reflection. MS’ top listed stock pick is Merlin Properties. “We also like any name with exposure to redevelopment and refurbishment expertise. A key opportunity in Madrid and Barcelona offices is to reposition and redevelop undercapexed outdated offices.”

Elsewhere…

  • London residential: international investors are expected to step up investment in inner London, driven by an optimistic rental growth outlook, longer-term capital appreciation and a weaker pound.  The significant demand supply imbalance across inner London is “caused by the challenges in obtaining planning consents, together with developers finding it difficult to commit to new construction starts due to the uncertainty caused by Brexit,” explains Ashley Osborne, head of UK residential at Colliers International
  • Investor interest in alternatives continues to grow.  According to PwC’s Emerging Trends 2019, investor exposure is highest is highest in hotels, student housing and flexible offices while student housing tops the wish-list for the year ahead. “Alternatives are supported by strong demographics, and they are seen as part of the industry’s structural change towards operational assets and property as a service,” says PwC. Investors, developers and operators are also looking at less established markets, such as retirement living or hybrids like coliving where existing management skills can be easily transferred. “The scope for consolidation and acquiring sizeable market share will make these markets attractive not just to operators from other sectors, but also new entrants to the market from overseas,” says JLL.

james.wallace@realassetmedia.com

We are superheroes in the market!

‘Last year investment volumes into Europe fell by 15% but they increased by 5% in CEE, which had another record year,’ said Dariusz Forysiak, director, Investment Services Poland, Colliers International.

Central and Eastern Europe is playing an increasingly bigger role in the Continent’s property investment market, delegates heard at Investment Briefings’ CEE and Europe Outlook Panel, which was held in Warsaw this week. 

‘Last year investment volumes into Europe fell by 15% but they increased by 5% in CEE, which had another record year,’ said Dariusz Forysiak, director, Investment Services Poland, Colliers International. ‘We are superheroes in the market, with €14 bn in transaction volumes in 2018.’

In all 6 countries in CEE the office sector drove the market, with a 60% rebound in volumes,  attracting €5.6 bn in investments, mainly focused on the capital cities.  

The logistics sector is also in investors’ sights, with a 20% increase. Even American investors, who have been net sellers of CEE assets, have been buying logistics assets. ‘They are the first in the queue,’ said Forysiak.

Poland was the star, recording 40% growth year on year and attracting €7.2 bn in investments, compared to a 40% drop in the Czech Republic to €2.6 bn. Offices in Warsaw were sought after by investors ‘queuing around the block’, but the market was also driven by regional cities and by the continuing success of the logistics sector, which shows no sign of abating.

Keynote address given by Dariusz Forysiak, Director, Investment Services, Poland, Colliers International at the Investment Briefings CEE & Europe Outlook Briefing, Warsaw, January 2019.

On the negative side the pace of growth is slowing compared to 2016 or 2017 and there are worries about the impact of Germany’s economic slowdown on the region. Labour shortages, especially in the capital, are leading office landlords to worry about whether their tenants will find employees, said Forysiak.

However, ‘we are still positive on the year ahead,’ he said. ‘2019 will be as good as 2018 because the economic fundamentals are good. Wages are rising, unemployment is low and people have money in their pockets to spend’.

High consumer confidence is the reason investors are still interested in retail, despite the negative vibe around the sector. ‘Retail had an 8% drop last year, but it still represents 40% of investment volumes and is still attractive,’ said Forysiak. ‘In Poland it is regional cities that drive retail.’

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It is all about the asset

In an increasingly competitive market it is more important than ever to be selective and thorough, looking at every deal in great depth and from every aspect

In an increasingly competitive market it is more important than ever to be selective and thorough, looking at every deal in great depth and from every aspect, Alexander Fischbaum, managing director, AF Advisory, told Real Estate Day.

‘We see a lot of capital availability from an ever wider range of sources, including many new entrants with specific requirements and a specific project,’ he said, proof that investor demand is definitely there.

‘We source a lot of core plus and added value deals for our clients, we run a slide rule over them and what we see is that 90% of deals fall away and 10% we think are interesting that might have been overlooked,’ he said. ‘Of these, 5% we get excited about’.

Once the potentially interesting deals have been identified there are many aspects to look at, he said, such as ‘the development of a particular location, the additional transport infrastructure that is being put in, the alternative uses, the potential changes of use. At a time when the market is so competitive, whether we source or finance the deal, you need to look at the deal, the value behind it, what value you can create and how, on a low current yield in historic terms, you can create some outperformance if the market shifts away from under you.’

The goal, Fischbaum said, is ‘to have longer income, better income, additional flows, different use, everything to really get into the nuts and bolts of the single asset. For us it is not about sectors or any other strategy but it is all about the asset.’

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UK & European Real Estate Markets in 2019: Five Big Themes

Today, we take a closer look at how macro, political, regulatory and real estate-specific variables are influencing financing liquidity, appetite, and pricing.

4. Finance

Debt markets have the unenviable task of pricing in the impact of several significant macro variables for which a wide range of permutations still exist. Political risk, such as Brexit and US-China trade war tensions, and the impact of rising interest rates across Europe, UK and the US, all still weigh on sentiment.

In addition, concerns of late-stage cycle in real estate, the prospect of moderating GDP growth real estate performance and historically low investment yields across many markets all feed into lenders’ appetite for new lending.

The consequence is likely reduced liquidity for high LTV loans from non-bank sector. Stricter regulations have long restrained banks from operating in the space, leaving the market open to private debt providers. However, the pace of capital raising in this market is showing signs of slowdown. Prequin reported declines in capital raised for direct lending and distressed lending in 2018. Banks are expected to maintain disciplined lending with moderating LTVs in more conservative senior deals, as lenders across the board seek to re-evaluate the outlook for rental growth across sectors where the ‘winners’ and ‘losers’ are diverging sharply.  

While debt remains a defensive means to secure exposure to real estate, there was a notable uptick in capital deployed towards alternative sectors, such as residential markets (student accommodation, PRS and retirement living), where long-term demographics suggest a degree of resilience in a slower or retracting market. According to PwC’s Emerging Trendsin Real Estate 2019, banks have been reluctant to fund speculative projects, insisting on pre-lets. Alternative lenders may be more open-handed, liquidity remains modest.

CMBS issuance rebounded in 2018 with around €3.4bn in new issuance, compared to just one deal the prior year.  Morgan Stanley managed to price the £349.1m Salus ELoC 33, backed by Brookfield’s CityPoint Tower in the City of London, ahead Securitisation Regulation came into effect at the turn of the new year which imposes greater transparency and reporting requirements on new transactions pre-pricing, and post closure.

This could lead to a slower start to the New Year in new issuance as compliance with new regulations may impact deal execution timing and costs. Nevertheless, Morgan Stanley has forecast at €5bn for 2019 in European CMBS new issuance, a previous ‘new normal’ benchmark in the last mini-revival for the sector five years ago.

Investors are focusing on income

The start of the year is quiet as expected in the UK market as uncertainty over Brexit persists, but things will soon return to normal after a slow Q1, according to Fidelity International.

The start of the year is quiet as expected in the UK market as uncertainty over Brexit persists, but things will soon return to normal after a slow Q1, according to Fidelity International.

‘We expect there will be an agreement and no falling off a cliff, but undoubtedly there will be question marks until Brexit is resolved, but we see no risk to occupational demand or a big shock to rents in the short term and that should help protect performance in 2019,’ said Kim Politzer, director, head of research, European Real Estate, Fidelity International. ‘The first quarter of the year is likely to be quiet, but then activity will pick up.’

Retail is the biggest challenge for the UK market and continuing falls in values are to be expected in the sector in the next 12 to 24 months.

‘Fidelity International’s forecast is that the price of UK retail assets could fall by up to 70%,’ said Politzer. ‘Retailers cannot afford the rent at the moment, profitability has been squeezed by increases in the minimum wage and business rates, so we need to see significant changes in pricing.’

The risk, she said, is that ‘this trend could spill from the UK into Europe, which is why we are bearish and underweight in retail.’

Looking at the EU market in general the themes are similar to the UK market on the sectoral side, she said: ‘Retail will be quiet, there is a strong demand for logistics across the European markets and everyone is acutely aware that we are late cycle’.

Everyone mentions the late cycle, but this awareness does not stop investments. ‘Investors now want assets that deliver a long stable income for when the downturn eventually comes,’ said Politzer. ‘The real focus will be about income, making sure that assets that are acquired or are being actively managed are going to deliver a long stable income stream so you are protected when the correction in the market comes, be in 24 or 26 months’ time.’

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Investor sentiment in Europe is still strong

Jonathan C Hull, CBRE, tells Investment Briefings that the late cycle is causing concern but not stopping investments in offices and logistics.

Investments keep coming into the UK and European property markets despite concerns about the late cycle and political uncertainty, said Jonathan Hull, managing director, EMEA Capital Markets, CBRE.

‘The late cycle is mentioned all the time, in every meeting you go to, but people still keep investing,’ he told Real Asset Day. ‘This is because people are struggling to see where else they could invest and generate the same kind of returns that they can get in real estate across the major sectors’. 

The office and logistics markets in particular are doing really well, he said, and they have been ‘very consistent’, giving investors some certainty, while retail ‘continues to cause some concern’.

Investor sentiment continues to be strong, he said: ‘We see strong inflows from Asia and from the US into EU markets’.

The UK is a slightly different story. ‘The UK is further ahead of the cycle compared to many other European countries,’ he said. ‘The UK has seen strong transactional volumes in 2018 but it is true that people recently have looked at the market and have been a little more cautious.’

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OUTLOOK 2019 (Warsaw) – CEE expects positive year as markets reach plateau

A record number of attendees joined our OUTLOOK 2019 Investment Briefing at the Warsaw offices of Colliers International and both audience polls and the research presentation suggested a plateau in markets for 2019 with investment volumns expected to be similar to 2018.

A record number of attendees joined our OUTLOOK 2019 Investment Briefing at the Warsaw offices of Colliers International and both audience polls and the research presentation suggested a plateau in markets for 2019 with investment volumns expected to be similar to 2018. Audience polls also highlighted political risk as the major concern and logistics as the sector most likely to see the highest growth. It was a very interactive discussion with the expert panel and we will bring you the insights, research presentation and video highlights of the discussion over the next two days in The Real Estate Day.

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UK & European Real Estate Markets in 2019: Five Big Themes

Transaction volumes across Europe are expected to fall for a second consecutive year in 2019, predicts Colliers International.

3. Transaction volumes & capital flows

Transaction volumes across Europe are expected to fall for a second consecutive year in 2019, predicts Colliers International. While 2018’s full year volumes are still to be released, Colliers predicts a fall of around 10% from 2017’s levels, which implies around €256bn for 2018. The scale of the tail-off forecast for 2019 varies from “slight” to “moderate”, which implies up to more than 10%. This suggests Europe could see volumes for the year down to around €230bn.

  • JLL says: “There are signs that activity is slowing as we move into 2019 and, while demand remains robust, volumes are likely to moderate…. Ongoing investor selectivity and reluctance to recycle capital, due to the difficulty in finding alternative income-producing assets, are likely to limit investment growth.”

However, platform or entity transactions are expected to again prop up overall transaction volumes this year which flatters the perception of the market’s liquidity and investor universe. 

  • PGIM Real Estate explains: “Rather than reflecting new capital sources or a churn of existing investors into new fund vehicles – creating a point at which there is a choice to rotate into other asset classes – mergers are more akin to a recategorisation of existing deployed capital. However, while global entity transactions increased by 70% in 2018, their volume – and potential distorting effect on activity – pales in comparison to 2007.”

Within the UK, predictions are more specific. 

  • CBRE forecasts “slightly lower” volumes – at around £65bn in 2019. The following three-year period – 2020 through 2022 – will see activity cool to around £50bn per annum. After which, volumes will rebound to £65bn in 2023. 
  • JLLis more bearish, forecasting around £55bn – assuming a Brexit deal is secured. Investors will focus on scarce prime product which consequently will limit volumes and drive further platform transactions. Foreign demand for UK commercial real estate remains healthy, with overseas cash accounting for over 40% of all investment, according to Colliers, driven by Asian capital, followed by European and US investors.

According to INREV’s Global Investment Intentions Survey 2019:

  • Institutional investors intend to deploy a minimum of €72.4bn of new capital into the asset class in 2019, including around two-thirds, or €47.6bn, of this total through non-listed vehicles. 
  • Half of all investors will increase their allocations over the next two years.
  • For investors targeting Europe, there’s a significant shift towards core, which rose from 31.8% to 39.1%, while opportunity virtually halved to 9.8%.  Value added funds remains preferred investment style (51.1%) with investors still attracted to the risk-adjusted return prospects.  
  • INREV explained: “These results suggest investors may be taking a more risk-averse approach to their real estate investments, in preparation for the approaching late stage of the current cycle.”

Final thought: While there remains considerable capital to deploy in 2019, new capital raising appears to be tailing off. Preliminary Preqin data for European-focused funds (up to November 2018), shows that the amount of capital raised was only a little more than half of that achieved in 2017. The true scale of which is yet to be revealed.