European Real Estate Snapshot

April 2019

European Markets Overview

Focus of the Month

Real Estate Focus of Sovereign Wealth Funds

Sovereign Wealth Funds (SWFs) have $6-$7 trillion in assets under management, which accounts for about 6% of global AUM of institutional investors. Historically, majority of SWFs focussed largely on fixed income. Post the financial crisis, amidst falling interest rates, SWFs started dedicating increasing amounts of money into real estate and infrastructure given their long investment horizon and no real need for liquidity or capital adequacy. Investments in alternatives peaked in 2015-2016 with SWFs snapping up trophy assets across the board from London to Manhattan.

Real Estate focus of SWFs

Real estate has been a key component of most SWF portfolios due to alignment with funds' long-term investment horizons and the diversification it offers.

• Asset allocation - Alternatives grew from 19% to 23% of AUM from 2010 to 2016, while the share of Fixed Income dropped from 40% in 2010 to 30% in 2016. However, there has been some 'fatigue' thereafter, with a 40% decrease in the number of SWF investments in private real estate between 2016 and 2017. The number of direct real estate investments dropped from 77 to 42 in 2017. Luxury hotels investment, which was also the focus of the real estate strategies of several SWFs has also declined with 5 deals in 2017, down from 18 deals in 2015 to 11 in 2016.
• Investment strategy - While SWFs invest mostly through the direct route and across all strategies, they have also been seen to invest through private real estate funds. Investing directly provides the benefit of greater control over the management of the assets, and not being bound by the buy and sell timelines of the fund's mandate. On the other hand, investing through funds offers diversity in terms of strategy and geography as well as better deal sourcing opportunities in local markets.

Impact of global headwinds

Macro factors have influenced the activities of SWFs in the real estate space

• Late property cycle and competitive markets - SWFs are finding it difficult to deploy capital as more institutional investors have recently entered the sector leading to increased competition for high-quality assets which is pushing asset valuations upwards.
• Brexit - From being the top destination for investments in 2017, UK dropped off the top five destinations and was overtaken by Netherlands and France. There were only eight deals in the UK in 2018 vis-a-vis eighteen the year before by SWFs. Traditionally a favourite of Gulf sovereign funds, the uncertainty due to Brexit caused a sharp reduction in investment by investors like Abu Dhabi and Qatari sovereign funds last year.
• Geopolitical Factors - With the fears of US-China trade war clouding trade and global economic growth, funds have taken a cautious investment stance amid the growing uncertainty. Falling exports will affect the sovereign wealth fund growth rates and thus their activity.

Turning point in Real Estate investments of leading SWFs

Some of the largest SWFs have changed their investment strategies with changes in the global outlook

• Norway's $ 1 trillion sovereign wealth fund which is one of the largest institutional investors in real estate has overhauled its property investment strategy. The fund will reduce investment in real estate to 3%-5%, from the previous upper limit of 7%. The fund's investments are already at the lower level - the allocation as of Sept. 30, 2018 was 2.7%. Within real estate investments as well, the fund will focus on listed real estate companies which are less “complex and resource intensive” as opposed to unlisted assets. The new real estate portfolio will target at least 30% and no more than 70% of investments in the U.S. market, between 10% and 40% of the portfolio will be invested in the U.K., up to 30% in France, and up to 20% each in Germany and Japan, according to a document outlining the new strategy. Investments will not be made in development projects and will be confined to premium assets in big cities.
• Gulf investors, led by Abu Dhabi and Qatari sovereign funds, have been prominent investors of western commercial real estate. The investments in the US & Europe stand at a decade low, having fallen 36% to $5.8bn in 2018 versus $9.1bn in 2017, mirroring the levels post the global financial crisis. The geopolitics of the region along with macro factors have led to the sharp plunge in the investments. Oil prices falling to record levels led to less oil surplus for re-investment. In order to fund the budget gaps of cash-strapped governments, funds have rebalanced their portfolios towards more liquid assets, such as equities. Deploying capital at the peak of the cycle, and increasing interest rates in US & UK coupled with bottoming of yields have kept these investors on the fence.

Recent Deals and Pipeline

• In early 2019, the Abu Dhabi Investment Council (ADIC) decided to put up its stake in the iconic Chrysler Building up for sale.
• The China Investment Corporation (CIC), through a separate account handled by Morgan Stanley Real Estate Investing (MSREI), agreed to sell a portfolio of 10,000 German apartments for approximately €2 billion.
• China Investment Corporation (CIC) made plans to sell its Logicor assets in Romania. In 2017, CIC had taken over the logistics giant Logicor from the Blackstone Group.
• Oman SWF is in talks to sell 99 Queen Victoria Street to WeWork.
• Norway's SWF and AXA Investment Managers SA are looking to sell the Die Welle office complex in Frankfurt's business district.
• GIC launched a European hotel investment platform, Archer Hotel Capital, together with its Dutch partner. The platform is based on a portfolio of 11 hotels in Western Europe.

Key Themes

Increasing M&A activity in private real estate

M&A transactions in real estate continued to grow for the second year in a row. 2018 witnessed a record level of M&A activity with 44 transactions, representing a total volume of $5.5 billion, in comparison to 30 transactions totalling $3.27 billion of transaction volume in 2017. Both the number of transactions and total deal volume has more than tripled in the last five years, when there were 13 transactions with a total volume of $1.46 billion, in 2014. This data includes full, majority and minority stake sales of private real estate or real estate managers and excludes privatization of listed real estate investment trusts. While the total seller AUM has continued to grow over the past five years, the average seller AUM has been on decline, indicating an increase in the number of transactions.

Coworking market in Europe

London is Europe’s largest coworking market measured by volume of office stock (4.6%) leased by coworking operators. In continental Europe, the coworking space in most major office markets accounts for no more than 2% of the overall stock. Amsterdam is an exception where coworking is estimated to be c. 6% of the total office stock. Other major cities with over 100,000 sqm of coworking space are Berlin, Brussels, Milan, Moscow, Munich, Paris and Stockholm.

The impact of coworking on the London leasing market has been significant. WeWork is now the largest private office tenant which is remarkable considering it is only 8 years old. Leasing activity by coworking operators has ranged between 10-20% of quarterly take up for the last few years, bolstering leasing figures considerably.

Demand for coworking spaces is strong among smaller companies and start-ups. However, the supply of suitable and available buildings in popular locations is relatively tight. London’s office vacancy rates are low, leaving coworking operators and corporates in direct competition.

Age-Targeted Living

We are already seeing increased specialization of housing, from student to retirement, via co-living and build-to-rent. It is expected that these trends will become more prevalent as developers target specific age groups by catering more closely to their needs and aspirations. This will be especially true when it comes to older people. It is well understood that many of the family houses built over the last century are not designed for older people who might need additional support. Housing which encourages active living but offers flexible levels of extra care will become an established residential asset class in the years ahead, underpinned by the Europe’s ageing population. A rise in institutional investment, with investors looking for long-term stable income, is anticipated.

Big Data and Real Estate

Although real estate is already a massive source of data, a lot of opportunity still lies ahead to quickly tap this data for actionable insights. Players with strong presence in technology sector will have an advantage due to their existing business models for the profitable use of big data. This stands to alter the competitive landscape of real estate industry. The market is gradually expanding in the direction of complex, interconnected, high-tech, and automated services. Here, well-financed and technologically-leading generalists that can offer a standardized global service strategy will be in a position to strengthen their competitive advantages.

The strength for real estate providers lies in their proximity to the data source. Their new business models will most likely focus on aggregating information at the building, service and market levels. With the rising popularity of BIM ("Building Information Modelling"), along with sensors in systems engineering and in rental spaces, increasing amounts of data will appear. This data will contain insights about the operation, capacity utilization, and condition of the building and the systems installed in the building. As a result, owners and users will increasingly expect pre-emptive detection of technical malfunctions. Real estate service providers also will have to guarantee the building’s reliability of performance as a minimum requirement.

Funds in the Market

• In 2018, the number of European real estate funds in the market across strategies reached its lowest level in five years, with a total of 158 offerings. This was down from the five-year peak of 220 in 2017 and lower than the previous lows of 167 in 2014 and 2016. And yet, the five European funds that have closed so far in 2019 have all raised at or above their targets.
• Across all institutional investors, Europe continues to command the largest share of global real estate allocations at 48.5 percent, followed by the US at 32.8 percent and Asia-Pacific at 10.1 percent, according to the 2019 Investment Intentions Survey conducted by associations INREV, ANREV and PREA.
• In Europe, fundraising volumes have decreased the most among regional markets over the past five years. In 2014, the region accounted for $45.97 billion of fundraising in 2014, compared to $45.55 billion in the US and $17.08 billion in Asia. In 2018, however, Europe represented just $22.7 billion of capital raised, while the US and Asia held relatively steady at $43.55 billion and $17 billion, respectively.

Recent Transactions

Snapshot of Key Deals

• Direct Acquisition
• Property Financing