European Real Estate Snapshot

January 2019

Markets Overview

Key Themes by Geography United Kingdom

The London office market appears to be unaffected by Brexit. The total office take-up for 2018 till the end of November was 7% higher than the same period in 2017, and 33% higher than the 10-year average.

Investment volume in London also continues to be resilient, with the investment turnover in November 2018 totalling £1.11bn (16 transactions), recording the third highest monthly turnover in 2018 (till November). Total investment volume for the year stood at £10.68 billion, across 120 transactions, as compared to investment volumes of £10.41 billion over 113 transactions in 2017.

Leased hotels are currently on majority of investors’ shopping list as the demand for hotels in the UK continues to increase. There seems to be no dip in investment activity within the sector even as the UK's exit from the European Union draws closer. Demand continues to outweigh supply in the Edinburgh hotel market particularly, on the back of impressive tourism statistics.

UK housing prices showed a modest rise of 0.3% in November 2018 over the previous month and an overall increase of 1.4% from the start of the year. Despite the price growth, other key market metrics remained subdued, reflecting the period of heightened Brexit-related uncertainty. The GFK Consumer Sentiment Survey fell in November 2018, down to its lowest score of the year. This widespread loss of confidence comes as the ongoing Brexit negotiations pass through a key period.

Continental Europe

Germany : Germany consolidated its position as Europe’s safe haven for capital. The country accounts for three of the top six cities for overall investment and development prospects in 2019, with Berlin at the second position. Industry leaders believe that this growth is sustainable, supported by a growing population and a vibrant technology sector. With supply being unable to match the increase in demand in most sectors, development of land has become a key solution for ‘value-add’ strategy investors seeking office, residential or logistics buildings in strategic areas.

Ireland: Residential property prices in Ireland increased by 8.4% in 12 months ending October 2018. This compares to an increase of 11.7% in the 12 months ending October 2017. Residential rents rose by an average of 11.3% in the year to September 2018. This represented the tenth consecutive quarter in which a new all-time high for rents was recorded and in which annual inflation in rents was greater than 10%.

Portugal: The Portuguese office market entered its fifth consecutive year of growth in 2018, with increasing office demand and growing take-up since 2014. Due to its strategic location, availability of highly qualified workforce, a competitive labour market and fiscal advantages, Portugal became the preferred location for shared-service centres by many corporates.

France: Continued growth in prime Paris residential prices is expected, however at a slower rate as compared to 2018. The geography of prime Paris is expected to expand as demand outweighs limited stock in the city. Office demand in Paris is driven by business expansion, stemming from an improving economy, strengthening labour market and an overall positive political backdrop. The vacancy rates have plummeted to a record low since 2001, which in turn has put an upward pressure on rents. Further, the “Greater Paris” infrastructure project and the 2024 Olympic Games are expected to fuel future development in the French capital.

Hungary: Tourism in the Hungarian capital of Budapest has risen by 12% over the past three years prompting a recovery in the city's hotel sector and stimulating further demand for vacation property assets. While some of the world's leading hotel brands, such as Four Seasons, Ritz-Carlton, Kempinski and InterContinental are already represented in Budapest, many others will be opening over the next three years including Hyatt, Marriott's W and Luxury Collection.

Focus of the Month

Resurgence of European CMBS

2018 saw CMBS issuances pick up in Europe, with an average of nearly one transaction a month. The 13 transactions combined are worth €4.4 billion, as compared to the €735 million from 3 transactions in 2017. This uptick can be attributed to the strong fundamentals of underlying properties in almost all markets, a widening investor base on a hunt for yield, and an increased scope of profitability in these transactions. What started off with the traditional asset classes, increasingly witnessed a growing popularity for alternatives as well. Pricing was dynamic, with an initial narrowing of margins, followed by a widening due to market volatility and a moderate year-end tightening. 2018 may have been the year where CMBS established itself as a viable financing source and a profitable investment in Europe. Below is a deeper look into the nature of transactions that took place in 2018 and other aspects of the market.

European CMBS market ramp up

Strong macro-economic conditions, solid CRE fundamentals and a healthy investor demand have given a new life to the CMBS market.

Property Fundamentals – Most of the Central and Western Europe have cap rates lower than their lowest points in the previous real estate cycle due to a low interest rate environment. Rents have been stable and vacancies are declining except in the retail sector which is suffering from poor demand.

Cost of capital – With the tightening of the CMBS spreads, cost of capital for balance sheet loan versus CMBS has resulted in the surge in CMBS interest.

Supply – Banks are shifting away from prime lending to loans which meet the CMBS exit criteria, thus increasing the supply of loans which can be securitised.

Re-invest – As CMBS 1.0 trades are maturing, investors are looking to re-deploy these monies in the 2.0 opportunities.

Cross border – As investors in the US and Asia concentrate on diversifying their positions, there has been an increasing cross border demand for European issuances.

Asset Classes and Jurisdictions

Office remained the most popular asset type backing securitised loans, but the way has been paved for alternative assets as well in a range of different jurisdictions arranged by a number of different banks.

Office – Office has remained a favourite property type featuring in more than half the deals this year.

Retail – With the ongoing turmoil faced by this sector, headlined by prominent bankruptcies, CMBS has turned out to be the preferred source of financing, with banks making their lending criteria stricter.

Alternatives – As the retail sector suffers, it paves way for warehouses and logistics hubs. Several transactions involving industrial and logistics arranged by Morgan Stanley, BAML, Deutsche Bank, SocGen and Goldman Sachs’s securitisation of UK Hotels backed loan were seen in 2018. There have also been enquiries for student housing and the private rental sector which are the new asset types being explored for CMBS financing.

Jurisdictions – Countries featuring in the deals included the UK, Germany, Netherlands, France, Italy and first timer Finland.

Trans-Atlantic Comparison

The seasoned US market recovered much faster post the financial crisis with increased activity while Europe witnessed limited issuance in CMBS 2.0.

European market – This is a fragmented market with multiple currencies and jurisdictions, leading to various different real estate laws. This leads to difficulties in putting a sizeable portfolio of similar loans together for securitisation.

Underlying loans – US is dominated by conduits with some standalone large loans, whereas the European market is characterised mainly by standalone loans with very few diversified pools. The tail period in the US is 32 years for conduits and 8-10 years for standalones, whereas the European CMBS have about 2 years in the legacy book and 5 years in the newer transactions.

Ratings – Despite similar performance of the real estate markets, a large number of European CMBS transactions are in special servicing vis-a-vis the US. The senior loan delinquency rate is also much higher in the EU due to a larger share of CMBS 1.0 transactions with outstanding low-credit loans past their maturity.

Structuring

There have been some innovations in the transactions seen in 2018 which were driven by regulations as well as learnings from the crisis.

Asset side – Loosening of loan covenants doesn’t seem to have deterred investors, as rating agencies focus more on cash flows and hard events of default. Missing loan covenants have been replicated at the note structure level.

Innovation – Excess spread trapping mechanisms are being introduced when LTV is high. Transactions increasingly moved towards the full pro-rata structure undercutting the asset diversity but having a stable credit enhancement across the capital structure, showing the increase in competitiveness in this space.

Margins – In the beginning of the year, we saw margins tightening, and as trades picked up in an active market, the investor base widened. When the market became volatile after mid-year, margins began to widen as well. However, the year once again ended with a tightening.

Market Dynamics

With the yield premium offered to investors and cost savings to borrowers, CMBS has established itself as a key financing vehicle for European CRE albeit with some challenges.

Relative Value offered – Even when spreads were tightening, CMBS still offered a yield premium with the AAA tranche priced at 70bps vs. 10bps and 15 bps for ABS and RMBS respectively.

Demand – There is an increase in demand in the middle and bottom of the CMBS transactions, and the top remains thinner in comparison.

Excess Spread – Weighted-average note margins compared with loan margins varied from 120-160 bps in early part of the year to 30-130 bps towards year end.

Risks – Ending of the QE programme by ECB, global trade war concerns, market volatility, rising yields and a faltering of overseas interest in the European market will be the key factors affecting CMBS issuances. Tougher EU regulations coupled with limited investor base and supply of assets are other constraints that will impact future issuances.

Funds in the Market

Recent Fund Activity

Blackstone Real Estate Partners (BREP) IX Fund is about to raise $20bn making it the company’s largest real estate fund, focussing on the worldwide market in global logistics, ‘innovation cities’, global leisure and travel and shortages in rental housing.

Oxford Properties privatized Investa Office Fund by shelling 3.3 bn AUD. This signifies the second largest investment in Australia by OMERS, Canada's largest pension fund.

Skybridge and EJF Capital launched Opportunity Zone non-exchange traded REIT which is diversified across geographies and asset types. It has a mandate of investing in US Treasury-certified opportunity zones, which are communities where recycled capital gains can benefit from a favourable tax treatment.

Recent Transactions

Snapshot of Key Deals Direct Acquisition Property Financing

Key Indices

European REITs North American REITs