July 2008


Battered by the credit crunch, Europe’s real estate players are increasingly looking at cross-border property investment. Fiona Rintoul sees the plus points of assembling an international portfolio – as well as the pitfalls ... property_skyline.jpg There are few sectors that have escaped the credit crunch entirely unscathed and real estate isn’t one of them. “Fear is back,” begins the 2008 Emerging Trends in Real Estate Europe survey from Price Waterhouse Coopers (PWC) and the Urban Land Institute (ULI). “Battered by the sub-prime crisis in the United States, Europe’s real estate players are wondering when life will get back to normal.”

As the Emerging Trends survey goes on to note, in Europe at least, the missing link is debt. “There is a major price correction going on, being driven by the availability of debt,” opines one particularly pessimistic interviewee. “The longer that debt remains an issue, the bigger the price correction. At present, we are looking at a 20-30% fall in capital values across Europe.”

But while the real estate markets in Europe and elsewhere have not been without their problems post-sub-prime, they've not been without their bright spots either. “Investment opportunities are abundant within the property sector across Europe and elsewhere, despite the continued turmoil in the financial markets,” says Simon Hedger, director of real estate portfolio management at Principal Global Investors.

This is a message that isn’t falling on deaf ears. The 2007 Manager Search Trends report from Mercer, which is based on the activity reported through the investment consultant’s global client database, showed that searches in alternatives were up by approximately 20% across the world, with real estate in particular experiencing increased popularity. Sixty-two searches were performed in 2007 versus 12 the previous year, although the amount placed remained virtually unchanged at $1.8bn.

Large volumes
Such has been the volume of increased interest that the AUM of the likes of Aberdeen Property Investors has grown from e5bn to e30bn in the past four years. This was partly down to corporate acquisitions – Aberdeen took over Goodman Property Investors in Australia and the German firm DEGI Deutsche Gesellschaft für Immobilienfonds mbH in the period – but was also “due to organic growth”‘ says Ubbe Strihagen, international director at Aberdeen Property Investors.

There’s been considerable interest in property from retail investors in many countries, Germany being a key European example. As stock markets started to wobble, German retail investors headed for the safety of money market funds and open-ended property funds (offene Immobilienfonds), a perennial favourite despite the scandals that afflicted the funds a few years back, with the result that the German open-ended property fund sector attracted net inflows of e3.1bn in the first quarter of 2008.

But growth at the likes of Aberdeen Property Investors has been driven primarily by institutional demand. “There  is a measurable increase in the allocation to real estate by institutional investors, who have been under-allocated in recent years,” says Thomas Beyerle, head of research at DEGI. “We see the real estate allocation in portfolios increasing from an average of 5.6% to 8.3%.”

There is increasing demand, particularly from pension funds, for international exposure to real estate. And international is the key word here.

“Pension funds have delisted in the domestic market and are increasing their exposure to the international market,” says Strihagen. “They have been lifting their allocation to real estate in the last three to four years, but what is even more notable is that they are starting to look internationally.”

This is a trend that started in the Netherlands and Scandinavia where you have large pension funds and small domestic real estate markets. But it’s a trend that Strihagen sees spreading to other markets. Part of the rationale for the DEGI takeover was to have a strong platform in Germany from which to offer investors international exposure.

“Capital in Germany wants to go outside,” says Strihagen, noting that Aberdeen Property Investors will also use DEGI to provide international investors with exposure to Germany. According to ULI/PWC, there are currently 250 available global real estate funds with $81bn under management. These are numbers that seem set to rise as institutional investors in particular invest increasingly in the international property markets through funds.

“Institutional investors are becoming more aware of the benefits of adding global real estate to their portfolios,” says the Emerging Trends survey.

Poor home performance
This drive to look outside the home market may to some extent have been motivated by poor performance at home, for example in Germany a few years ago and in the UK today, but there are also strong diversification benefits to be gained from investing a real estate portfolio internationally – stronger than in other assets classes. In some ways, real estate is the perfect diversifier because it has a low correlation with equities and bonds and there is also a low correlation between geographical regions. Two cities in the same country can even behave quite differently.

“That’s the big difference between property and equity,” says Strihagen. “Equity markets mirror each other overnight, but property is very locally driven.”

Of course, cross-border investment in property also brings its challenges. Regulations and valuation methodologies can vary significantly from market to market, particularly in Asia, a favourite market at the moment, but one that is extremely fragmented.

In both Russia and some Asian markets, transparency can be a big issue. The only way to get round this is to have people on the ground who understand the local markets. That in turn is expensive, meaning property investment firms have to achieve a certain size to be viable.

Support for growth
Increasingly, developments in global infrastructure support the growth of cross-border property investment. “It seems clear that the legislative, regulatory and advisory infrastructure is now firmly established to help transport capital around the world to non-domestic markets both close and far from home,” says PRUPIM's second quarter 2008 International Real Estate Perspective report.

But it’s a task that few pension funds, let alone retail investors, would want to take on themselves. The more international property investment becomes, the more compelling is the case for real estate funds.

Nonetheless, in a market that is already crowded – the ULI/PWC survey says there are currently more than 470 real estate funds in Europe with e336.5bn under management – there is only room for top-quality players.

“Too many fund managers are launching funds,” says one respondent to the Emerging Trends survey. “Over the next two years there will be fallout from those without expertise.” ©  2008 funds europe

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