Florian Glock
Charles Kingston
Charles Kingston - REFIRE
Over 300 of Germany’s real estate fund managers at the recent BIIS Jahrestagung in Frankfurt heard from a number of prominent speakers that little could dampen the prospects of at least three more good years of rising commercial real estate prices.
Philip La Pierre, head of European investment at leading fund manager Union Investment, took a more tempered view. He gave a lively presentation entitled “Yields and risk premiums – are the markets slowly getting spooky?” He gallantly took it upon himself to share with his audience how one of the biggest real estate investors in Europe views current market pricing.
He cannot help being surprised, he admitted, that the market continues to lurch from one record deal to the next, that low yields are being trumped by ever lower yields, and the glossy market reports from the big broker groups are still sparing no expense in their drive to outdo their competitors in painting optimistic scenarios for their investor clients.
The standard arguments for the rosy vista are wheeled out in every discussion, he said. And indeed, they do have a certain validity. There’s the wall of money that needs to be invested. That’s not disappearing overnight. If anything, new sources are appearing daily.
Office rental income is rising, and will continue to rise because of the low level of construction. Vacancy rates across Germany have been falling. Investors with a more opportunistic approach than Union Investment tend to input more rapidly-rising rent levels to their Excel spreadsheets than may occur – and foreign investors are to the fore in anticipating more rental upside than conservative domestic investors. This much is true, granted La Pierre.
Nonetheless, such heady valuations as he’s now seeing ARE somewhat ‘spooky’, he conceded, and more than a little reminiscent of the heady days before the markets went into a tailspin.
He gave a number of useful in-house examples. Leipzig, not exactly an international hotspot, where Union pulled out of bidding at a multiple of 19, to see it go for more than 21 times annual income. Ambitious pricing, as he sees it.
Or Berlin, the hottest German market at the moment. A good location on the Leipziger Strasse for €40m, 26 times income, 3 years remaining lease term. Again, it was not so much the multiple as the speed with which the rival successful bidder swooped in to grab the property that was the ‘spooky’ thing.
Logistics, the surprise hot sector of last year, threw up many examples of where Union regularly came up against more aggressive buyers, willing to go well north of 18-multiples to lock up the deal. As La Pierre said, to an outburst of nervous laughter, such toppy prices were being justified by the advising brokers as characteristic of a ‘Paradigm Change” – rather than, in his view, just representing a ‘very high price’.
Yes, we know that the internet and e-commerce are creating new logistics demand, but - Hmmm, just where did we hear all that paradigm change business before?
Naturally, Union Investment has access to the best advisers, sophisticated valuation experts, and its own extensive experience. This doesn’t shield it from making mistakes, of course, or overlooking new realities. Union is still a major buyer across Europe, and a big investor in project developments. It is inevitable it will lose out to nimbler competitors on many deals. It has a duty to its savers to avoid risks that others might be comfortable taking. But the risks ARE rising, said La Pierre, not just in the price levels but particularly in the deal structures and the small print in the contracts.
The lowering of guarantees, co-exclusivity with others in the process rather than being the sole player, the disappearance of capital gains discounts in competititve deals – these all represent extra risk in the buying phase that have to be added to the market risk. Taken together, in La Pierre’s view, the market is back where it was in 2007, if not already beyond that point.
Hence it’s time again for investors to review their commitment to first principles, he says, and gave his audience some advice from Union’s in-house investment manual.
In the current climate, don’t be tempted to revalue your assets at every opportunity to sexy up the balance sheet. Buy very selectively, with the emphasis on yield, quality and location, rather than capital appreciation. There is value-added potential even in every core investment. Use the time now, where prices are strong, to improve assets in your holdings even if you plan to sell them, and reduce the long-term risk of holding assets with poor reversionary potential.
Sound words, in our view. Of course, all investors inevitably believe that they are prudent, cautious and alert to market tipping points. But the sheer weight of money, low interest rates and the ‘spread above the risk-free return’ argument are lulling many investors into a cosy sense of being unable to do anything wrong. There may indeed be few visible clouds on the German horizon, as other speakers at the same gathering suggested. But as George S. Patton liked to say, when everyone’s thinking alike, then somebody isn’t thinking.
