JP Morgan Research Report - Opportunity Seized Opportunity Missed
Transcript of JP Morgan Research Report - Opportunity Seized Opportunity Missed
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1 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe
Opportunity seized,
opportunity missedThe case or opportunistic real estateinvestment in Europe
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2 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe2 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe
Executive summary The process o deleveraging as well as badly needed economic and political reorm in
Europe will be long, protracted and painul. Turmoil and uncertainty will persist or some
time yet but it will also provide the basis o opportunity or experienced investors.
The real estate market is quickly moving in avour o the opportunistic investor. However,
this phase o opportunistic investment will likely be dramatically dierent rom that o
previous episodes. No longer will the manager be able to rely almost solely on debt uelled
returns. The backcloth o little or no growth places the emphasis squarely on the ability
o the manager to drive investment returns orward.
Managers with the track record, breadth o nancial and operating experience, as well as
the credibility with which to mitigate execution risk, are increasingly scarce and will carry
a premium in this environment.
Unlike previous phases o opportunistic investing, no investor will likely be rewarded or
taking macro positions on Europe. The winning strategy may have to be underpinned by
a recognition o the value derived rom the current state o extreme risk aversion, the
recapitalisation o deunct capital structures, the active management o assets which have
been in suspended animation or the last 45 years and, above all, a recognition that the
diversity o the European real estate market is both mispriced and undervalued.
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Exhibit 1 | Its opportunistic investing, but not as you know it!
Source: J.P. Asset Management
Keythemes
Early2000s
Today Implications for theinvestment manager (IM)
Macropositions
The European market was bothopaque and inecient. It was alsothe subject of frantic de-regulationand increasing EU accession. Thisallowed for significant re-pricing ofmarkets allowing macro positionsto be taken (CEE or Germanresidential).
Improvements in transparencyand liquidity transformed themarket in terms of pricingeciency. At the same time theincreased polarisation inperformance precludes the takingof macro positions on particularsectors or specific regions.
Opportunistic returns in the early2000s were both reliant andfuelled greatly by the availabilityand cost of debt. Investmentstrategies could be very simple acquire property, ensure it washighly geared and wait for yieldsto compress.
The pool of commercial realestate (CRE) debt is and will bemuch reduced. Managers willalso need to contend withsubstantially lower loan to values(LTVs) and higher margins.
The IM with a good trackrecord and goodrelationships with themajor lenders will be ableto take advantage ofstapled debt in theopportunistic segment ofthe market.
At the time Europe was enjoying aperiod of unprecedented growth,in the midst of a long bull-runwhere property investment cameto be seen as risk free.
Economic recovery will be slow andpainful with little or no growth inthe medium term. This means thatone of the most important driversof opportunistic returns will be lesssignificant.
The IM has to relyincreasingly on hands-on,operational expertise.
Investment returns were drivenprimarily by debt and relatively highrates of economic growth.
Investment returns will be moremodest and, as important, the keydriver of value growth has shiftedmost decisively to the ability of themanagement team.
IM with the financial andoperating experience willhave a distinct competitiveadvantage in counteractingthe eects of lower growthand less debt.
The IM has to have directaccess to local marketsand network of partners.
Financing
Growth
Investmentreturns
Definitionof core
Investmentuniverse
Execution risk
Investmentmanagementindustry
Leasingmarkets
Developmentactivity
Development activity was at a highpoint providing a steady supply ofcore assets to the institutionalmarket. At the same time demandfor such assets was restrictedprimarily to domestic institutionalsources.
Extreme risk aversion has led to aredefinition of core. Core assetshave to have a tick in all the rightboxes meaning that even thoseassets with minor impairments, andotherwise regarded as institutionalin a more normal market are beingpriced as secondary.
IM will be able to takeadvantage of assets withminor impairments andotherwise regarded asinstitutional throughinjection of capital andactive management
During the early 2000s, investorshad to go to Tier II and III marketsand the smaller and less liquidcentral and eastern European (CEE)markets to generate the sort ofopportunistic returns required.
The opportunistic investor is beingrewarded for taking risk even in thelarger and most transparentmarkets in Europe. Extreme riskaversion has meant that reasonablereturns can be generated in majorcentres throughout Europe.
Local knowledge andexperience in core marketswill be crucial for the IM
The weight of capital and, inparticular, the ready availability ofdebt, greatly reduced the level ofexecution risk in the market.
The process of de-leveraging andgeneral risk aversion has increasedoverall risk of successful executionof transactions.
The credibility of the IM willbe critical in convincingcounter parties of the abilityto successfully completecomplex transactions
Characterised by a wave of newmanagers with little or no trackrecord or experience of depressedmarkets.
The investment management industryhas consolidated as evidenced bythe number of funds looking to raisecapital. Regulatory change (AlternativeInvestment Fund Managers Directive)will speed up this process.
IM with deep financial andoperating experience ofdepressed markets are atpremium
Real estate cycle was characterisedby a synchronised recovery andgrowth phase across the Europeanmarket which, over a period, spilledover to Tier II markets as well asthe periphery.
The downturn was notsynchronised whilst performancehas subsequently been highlypolarised. This divergence isevident in both the leasing andcapital markets.
The bifurcation of marketsprovides opportunity forthe IM at both ends of thespectrum. To take leasingrisk in those markets whichcontinue to experience lowvacancy and developmentactivity and seek changesof use in markets withstructural levels of vacancy.
Development activity in the early2000s was at peak levels with thehighest construction boom in mostof the major European markets.
Development activity has been lowin most locations throughoutEurope during this cycle. This hasled to a shortage of grade A stockfor occupiers as well as anincreasing shortage of investment
stock for institutions.
The IM with refurbishmentand developmentexperience will be able tofeed the institutionalappetite for coreinvestment assets which the
market has failed to deliver.
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Dierent drivers o investment returns
As the market continues to move sideways, with little evidence o a robust or sustainable recovery
in values, the driver o value growth has shited rom debt to the asset managers ability to create
value. The increasing shortage o debt in commercial real estate (CRE) and the prospect o little to
no macro growth in the short term will inevitably lead to more modest returns at the opportunistic
end o the market. However, o equal importance is the act that the real driver o value creation
has shited to the asset management team, their track record, operational experience and credibility
in mitigating execution risk.
Exhibit 2 | Drivers o capital value change
60
70
80
90
100
110
120
130
140
150
160
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Cap ta va ue n ex
Finan
ciale
xperien
ce
Operational experience
Source: J.P. Morgan Asset Management, IPD
Exhibit 3 | Contributors to investment returns
Source: J.P. Morgan Asset Management
Financial leverage
Market
Asset management
Financial leverage
Asset management
Market
Pre-crisis Post-crisis
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Capital really does have value
Not only has the majority o investment capital gravitated to the core market, but in so doing, has
redened the very meaning o core. Extreme risk aversion has meant that the investment
universe o core property has shrunk during this cycle. As a result, a large proportion o assets
previously considered institutional but with minor impairments or, slight blemishes, are now
being priced as secondary.
Exhibit 4 | Risk aversion shrinks denition o core today
Source: J.P. Morgan Asset Management
Moreover, these institutional assets in good locations are being mispriced as secondary despite
having deects which are easily sorted through an injection o capital, or simply by improving its
management.
Exhibit 5 | Secondary pricing at attractive spreads
Source: J.P. Morgan Asset Management, CBRE
Liquid assets
need to be
grade A in every
respect: location,
asset quality,lease length,
covenant.
Extreme risk aversion has
left behind whole swathes
of assets which just fail to
meet the grade even
though impairments can be
rectified with injection of
new capital and active
management.
Core
investment
universe
today
Core investment
universe in
normal market
conditions
Prime
Spread between prime and secondary property in the UK
Secondary
12%
10%
8%
6%
4%
2%
0%
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
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Furthermore, what is abundantly clear is that yield spreads between prime and secondary markets
are now at a point previously unseen. Going as ar back as the early 1990s, yield spreads narrowed
in the early 1990s, the early 2000s and again in 2006-07. They are correctly at their widest margin
refecting, above all, the extreme risk aversion evident over the last couple o years. It may be
unreasonable to expect these spreads to narrow to the 1% gap seen in 2007-08, but a narrowing
to 1.2%-1.3% would appear reasonable rom their current level o 2%+.
Exhibit 6 | Yield spreads - Prime v Secondary Markets (bps)
1.00
1.20
1.40
1.60
1.80
2.00
2.20
Q2-1991
Q4-1991
Q4-1992
Q4-1993
Q4-1994
Q4-1995
Q4-1996
Q4-1997
Q4-1998
Q4-1999
Q4-2000
Q4-2001
Q3-2002
Q2-2003
Q2-2004
Q2-2005
Q4-2005
Q3-2006
Q1-2007
Q3-2007
Q1-2008
Q3-2008
Q1-2009
Q3-2009
Q1-2010
Q3-2010
Q1-2011
Q3-2011
Q1-2012
Source: DTZ Research, as o June 2012
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Diversity is mispriced and under valued
Given the scale o the economic and political problems around Europe, it is inevitable that the
region is being treated as a single, coherent entity, and priced accordingly. However, the decline
in values was not synchronised and neither has been the long and gradual recovery. The
perormance o both leasing and investment markets has continued to diverge in terms o
perormance and that is likely to exacerbate in the uture. The polarisation o markets creates
ideal conditions or opportunistic investors to thrive in: taking on leasing, reurbishment and
development risk in markets with strong leasing undamentals and a positive outlook, as well
as creating value through re-zoning and changes o use in markets where vacancy has reached
structural levels and a large proportion o vacant oce space is not likely to return to
productive use.
Exhibit 7 | Polarised Markets
0
1
2
3
4
5
6
Supply/demand balance
Amste
rdam
Milan
Madr
id
Brus
sels
Fran
kfurt
Rome
Barc
elona
Duss
eldor
f
Berli
n
Munic
h
Hamb
urg
Lond
on(City
)
Lond
on(WE)
Lyon
Paris
(CBD
)
supplyyears
Market Equilibrium
Source: DTZ Research, as o June 2012
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Development cycle
Real estate development activity around Europe is at a 30 year low. This means that, despite the
economic downturn, there is not only continuing demand or quality space rom occupiers, but
also a relatively low supply o new quality assets or investors as well. The lack o quality stock
available in the investment market has been made all the more severe by the strong infow o
long term institutional and sovereign wealth und capital rom outside the region.(3)
Exhibit 8 | Development is at a 30year low
0
1
2
3
4
5
6
Development completions as a % of total stock
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
30 year average
Source: PMA, as o June 2012
Wheres the product?Much o the attention has inevitably ocussed on the banking sector as a source o investment
grade product and, in particular, the act that we have not yet seen the promised wave o
distressed assets on the market. The banking sector in Europe has announced sales o EUR 200bn
over the past 24 months although only a relatively small proportion o this has actually been
executed. Even so, the level o announced sales account or less than onethird o the toxic
balance sheet in the sector as a whole. Banks will become a major source o investment product
but, or the time being, it is reasonable to assume they will seek to maintain the slow trickle o
assets into the market.
While banks are between a rock and a hard place, successive rounds o liquidity injected over thepast threetoour years have been successul in providing something o a respite. The transer o
assets rom bank balance sheets into the market has been slow and ponderous, and though there
is now evidence that this is picking up, the indications are that banks will seek to hold those assets
that continue to pay a coupon in the hope that time will solve the valuation issue. There is
however another group o assets which have been in suspended animation or the last threeto
ve years, where borrowers have lost all equity and where the banks have been unwilling to inject
the required capital to maintain values. These are the assets in the process o being placed on the
market as the banks have come to recognise that the ailure to invest over the last ew years is
costing them dearly as the deterioration in value is unlikely to recover any time soon.
As pressure continues on the banking sector, so the unding gap is wide and getting wider over
time. Indeed, the unding gap in Europe has now doubled over the past 12 months to an estimatedUSD 200bn as the new wave o banking regulation begins to take hold. The unding gap is unlikely
to be plugged in its entirety by alternative sources o nance such as lie companies and the
sovereign wealth unds.(6) This gap will inevitably lead to urther pressure on pricing or those assets
currently held on bank balance sheets.
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Exhibit 9 | Alternative sources o nance
Alternative sources o nance
USDb
illion
-800
-700
-600
-500
-400
-300
-200
-100
0
100
200
Insurance CosSWFPrivate equityOEFsUnlisted fundsCMBS
Banks
Source: Morgan Stanley, as o March 2012
However, distress comes in many dierent guises and banks are certainly not the only source o
distressed investment stock. Many German openended unds are now in liquidation mode and
will need to dispose o EUR 25bn plus in core European markets over the next couple o years
a scale o disposals which will undoubtedly impact on pricing in specic markets.
As a group, real estate investment trusts (REITs) appear to be least distressed but they will also be
net sellers in the short to medium term. The pressure on REITS comes rom trying to reduce
leverage, uel existing development plans in the absence o sucient debt in the market, and the
need to ocus on core competencies. Raising new capital in this environment is both dicult and
dilutive with equity markets remaining volatile and the majority o companies trading at a
signicant discount to net asset value (NAV).
The unlisted und sector will also be major sellers as many o the unlisted unds are coming to
the end o their lives as well as seeking to exit as a result o increased cost overheads ollowing
the recent introduction o new European Union (EU) legislation.
Finally, central and regional governments will denitely make up a large component o distressed
real estate sellers particularly in peripheral European markets. All governments are seeking to
raise new capital and the historic portolios held by the public sector is a potentially important
source o value. A number o signicant portolios have recently been placed on the market and
this trend is one that is likely to continue over the next onetotwo years.
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Case study
Distress comes in many diferent guises
Continuous waves o liquidity rom governments and central banks have enabled European
banks to delay the transer o distressed assets onto the market. This process will inevitably
speed up but or now will remain slow and torturous. However, the banking sector is by no
means the only source o investment grade product or the appetite o opportunistic investors.
Take, or example, the sello o EUR 25bn plus o real estate assets held by the German
openended unds in the process o liquidation.
This will give rise to two important trends. First, a signicant increase in investment product
rom distressed owners but second, and more importantly, the concentration o theseportolios will inevitably lead to an increase in pressure on pricing in specic sectors and
local markets. Over 80% o the European portolio o the German unds is in the oce sector.
Given that over hal o all the oce stock held by these unds is to be liquidated, the impact
on pricing will be signicant especially since oce transactions have made up less than
onethird o all investment volumes traded in Europe over the last ve years.
Most o these oce properties are held in Germany and France and, in these markets, we
do not expect there to be a signicant impact on pricing as the major markets in both
countries are liquid and likely to remain so in the oreseeable uture. However, the unds
also hold substantial portolios in the central and eastern Europe (CEE) and Benelux where
market conditions are dramatically dierent. Take the Netherlands or example, where
pricing is already under pressure, as vacancy levels continue to rise. In Amsterdam there is
now 1.1 million sqm o vacant space; an approximate 20% vacancy level. Onequarter o
these vacant oce buildings is owned by the same German unds and roughly 30% o the
vacant buildings are nanced by German bank loans.
The net result is inevitably a substantial all in oce values in a major European market and
signicant opportunities in terms o changes o use including the rezoning o oce space
that will never come back into productive use.
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Case study
There is no shortage o owners in denial
We recently saw the latest announcement o some o the progress made by governments in
recognising the hole they are in as well as an indication o how ar we still are rom nally
drawing a line in the sand.
By way o background, the rst hal o 2012 saw a dramatic all in investment activity in Spain
with just ve commercial sales closed in Madrid and Barcelona. This is not surprising given
that liquidity vanished in these markets as the economy deteriorated in Spain and investors
ocussed their activity on the larger, more transparent investment markets in core Europe.
The regional government in Madrid announced a disposal programme o a portolio in the
city which, as it turns out, is a good example o what we are likely to see in the comingmonths, as well as a great example o the act that many distressed owners have not yet ully
grasped the extent o the pain to come. The regional government will embark on a disposal
programme o about 100 assets with the rst round comprising the sale o 15 properties o
around EUR 62m. This process highlights a number o issues:
First, the relatively small lot sizes o the initial disposal programme. This could be
attractive to local investors in Madrid, particularly high net worth individuals, but is
unlikely to attract much interest rom international capital.
Second, because the disposal programme comes rom a public sector body, it will need to
adhere to a strict bidding process which can be long and cumbersome with considerable
risk that it may not actually be executed in the end. This too is likely to act as a deterrent
to international investors.
The third element is price. The Government is looking at a discount o 1520% on current
values. Such a level o discount is going to be wholly inadequate and, more than anything
else, refects the state o denial which continues to afict many o the distressed owners in
the region.
Similar portolios have recently been marketed throughout Spain, Italy and Portugal. Few
have transacted but only in cases where ar greater discounts have been secured. Pricing or
these types o assets will weaken urther and this market will continue to move in avour o
the opportunistic investor.
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Debt nancing
The pressure on the banks to shed real estate loans and assets will be a major issue or some
considerable time. The availability o bank nance in real estate will continue to dwindle(4). Banks
will come under increasing pressure to lend to the corporate sector and consumers, whilst
lending to real estate will continue to be seen as not just unprotable but marginal, given the
totality o the problem across the European economy. Real estate lending will continue to be
scarce and rationed to the two ends o the spectrum. Core investors will continue to access debt
albeit at lower loan to values (LTVs) and higher margins but so will opportunistic investors who
will be able to take advantage o stapled debt at the higher end o the risk spectrum(5). In both
cases, only good-quality sponsors will be able to access debt as banks not only consider the
quality o the investments but also the quality o the borrowers.
The stapling o debt is inevitable i banks are to succeed in cleaning up their balance sheets o
those assets that have been in suspended animation over the last ourtove years.
Exhibit 10 | Changes o UK banks net lending to property companies
-6,000
-4,000
-2,000
0
2,000
4,000
6,000
8,000
10,000
12,000
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
GBP
millions
Source: Bank o England, as o June 2012
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Scarcity value
During the course o this real estate cycle, there has been a dramatic allo in new unds seeking to
raise capital in Europe. There are all sorts o reasons or this including the general level o risk
aversion, the troubled history o unlisted unds and consolidation in the industry, as well the eect
o new EU regulation which is beginning to take its toll on the size and nature o the investment
management industry. One unintended consequence o this is the comparative scarcity o credible
and experienced managers with the mix o nancial and operating experience required to create
value in this environment. Credible asset managers are rare, carry a premium, and will have a
considerable competitive advantage in the years ahead.
Exhibit 11 | Manager Experience is Scarce
0
5
10
15
20
25
2004 2005 2006 2007 2008 2009 2010 2011 2012
Billions
Real estate funds capital raising in Europe
Source: PERE, as o June 2012
Regulatory change also importantThe nature o the opportunity unolding across Europe comes not just rom the shock to the
capital markets and the distortion to the leasing market but rom the nature and pace o
regulatory change as well. The eect o Basel III and Solvency II have been well chronicled and
serve to quicken the pace o change amongst banks as well as other institutional investors. But
regulatory change is also beginning to have unexpected consequences as in the case, or
example, o the German governments position on the Alternative Investment Fund Managers
Directive (AIFMD). Implementation o the directive has prompted the Government to introduce a
clause into domestic legislation which, to all intents and purposes, discourages institutional
investment in new openended unds. The consequence o this will be increased redemptions as
investors take heed o the new legislation, and hasten the demise o such vehicles rom the
European investment market.
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The opportunistic market continues to
move towards the investor...The low appetite or risk amongst investors, the range and diversity o equity active in the
market, and the shrinking pool o debt nancing available has meant that pricing has and will
continue to move in dierent directions depending on where the investor sits on the risk
spectrum. The lions share o capital fows have targeted the core market and then only in the
largest and most liquid markets around Europe. This segment o the market remains highly liquid
and pricing remains competitive. Indeed, there are no bargains at this end o the real estate
market. Such a situation is in sharp contrast to the opportunistic market where there is not only a
surplus o supply o stock over demand but prices will continue to soten.
Risk Capital/stock balance Key themes/rationale Liquidity Pricing
Trophy assets Excess demand over supply
Strong global equity ows
Long term horizon
Wealth retention
Reliable income
Liquidity
Very liquid Fair value
Core Excess demand over supply
Increasing supply (Banks and OEFs)
Mix o domestic and global capital
Debt is available
Rental growth
Stable income
Liquid Fair value
Midrisk Excess demand over supply
Increasing supply
Leasing uncertainty
Little debt available
Mispricing o risk
Illiquid Mispriced
Opportunistic Excess demand over supply
Increasing stock rom banks/OEFs
Little debt available
Distressed sellers
Capital market shit
Signicant discounts to book value
Regulatory change
Liquid at a price Mispriced
Source: J.P. Morgan Asset Management
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An opportunistic investment strategy
or EuropeGiven the level o continued uncertainty in the market, the shrinking pool o CRE debt and the
prospect o little or no growth on the horizon, an opportunistic strategy or the European region
has to be ounded on our key elements:
1 Extreme risk aversion
The market conditions that have characterised this market cycle have led not only to a level o
extreme risk aversion with a complete ocus on core, but more importantly to a redenition
o core itsel. Unless the asset meets narrow criteria in terms o location, asset quality, length
o lease or covenant, it will tend to all outside the institutional market or which there is ample
liquidity. The market has overreacted and the net result is a large swathe o good quality andinstitutional real estate that has been temporarily let high and dry. It may be that such assets
have a little vacancy, or the lease length may be on the cusp o what is deemed acceptable
minor impairments that can be rectied through an injection o resh capital or the active
management o the asset itsel. These assets are now being priced as secondary, but will re-
price as the market takes stock.
2 Recapitalisation
The balance sheets o European banks may be stued ull o distressed assets, yet only a trickle
has come to the market. Frequent injections o liquidity have provided something o a saety net
or banks that simply have not been orced to sell in the current conditions. It has allowed banks
to hold onto those assets that continue to cover interest payments and where, basically, the bank
is more than happy to simply collect the coupon.
However, there is another, much larger group o assets on bank balance sheets which are
languishing and whose values are deteriorating by the day. These properties need capital and
management but have been in suspended animation or a considerable time. The borrower
having lost most, i not all o his capital and the lender with inadequate asset management skills
and an unwillingness or inability to invest are aced with a pool o assets whose value is
deteriorating at ever increasing speeds. These are problematic assets whose impairments can be
ameliorated through the deployment o resh capital and/or handson active management.
3 Divergence is mispriced and undervalued
The European market is priced as i it was a single entity. But nothing could be urther rom the
truth. Not only did the downturn lack any real synchronicity but the pattern o perormanceand the outlook or recovery continues to show a considerable degree o divergence. The degree
o polarisation will increase allowing opportunistic investors to seek value at both ends o a
polarised market.
4 Asset management
Most important o all, the sort o opportunistic investment market unolding in Europe is unlike
anything in the past. The key driver o returns has shited rom the ability to deploy debt to the
quality o the investment manager. Their credibility, track record and handson operating experience
will be the key dierentiating actors in this new investment cycle.
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Opportunity I - Extreme Risk Aversion
Definition of Core
Attractive pricing
Yield spreads
Risk aversion has led not just to a flight to core but a re-definition of low-risk assets. The investmentuniverse for core assets has shrunk resulting in a universe of institutional assets in major markets that
are currently being priced as secondary. A group of assetswhich have minor impairments capable ofbeing rectified by an injection of capital and/or active management.
The opportunity to acquire good quality assets at historically attractive pricing and, in a segment of themarket, which will continue to be characterised by limited competition.
Yield spreads between prime and secondary, tier I and tier II markets as well as between core andperipheral Europe are at an all time high. These will correct and markets will re-price as Europestabilises over the medium term.
Opportunity I - Extreme risk aversion
Definition of core
Attractive pricing
Yield spreads
Risk aversion has led not just to a flight to core but a re-definition of low-risk assets. The investmentuniverse for core assets has shrunk resulting in a universe of institutional assets in major markets that
are currently being priced as secondary. A group of assets which have minor impairments capable ofbeing rectified by an injection of capital and/or active management.
The opportunity to acquire good quality assets at historically attractive pricing and, in a segment of themarket, which will continue to be characterised by limited competition.
Yield spreads between prime and secondary, tier I and tier II markets as well as between core andperipheral Europe are at an all time high. These will correct and markets will re-price as Europestabilises over the medium term.
Opportunity II Recapitalisation
Capital structures
Capital starvation
Suspended animation
Fixing capital structures through fresh injections of capital. There is an increased recognition by existingowners and the banks of the need to exit, or partner, at realistic prices.
Quality real estate managers in both the public and unlisted markets are in increasing need of freshcapital. This will become particularly evident as bank activity shrinks back into their respective domesticmarkets. The result will be a significant starvation of capital, particularly in regions such as the CEEand Benelux.
Whilst banks have been holding on to real estate on their balance sheet, they have neither activelymanaged nor supplied the sort of capital required to sustain value. There is, therefore, an opportunity toacquire assets which have been in suspended animation for the past four-to-five years and starved ofcapital and operating expertise.
Structured finance
Special situations
Provision of financing above that of the senior lender. Structured investments with the opportunity toparticipate in future capital appreciation.
Opportunity III Divergence is mispriced and under-valued
Economic polarisation
Tight leasing markets
Structural vacancy
Whilst regional growth will be modest and rather anaemic, the outlook at a city level will continue to bepolarised. Some of the largest and most dynamic centres have remained resilient to the downturn andshow a positive outlook in terms of rates of growth and net positive absorption going forward.
Over the medium term, there is likely to be strong demand for development and refurbishment activityable to deliver the type of modern space capable of meeting occupier needs. The European market willbe characterised by a shortfall in quality stock over the next two-to-three years.
Whilst vacancy remains low in the major markets, there are a number of other important markets whichare subject to structurally high levels of vacancy. This will provide the opportunity for changes of useparticularly in cities with a strong demographic base and high quality of life index.
No macro riskIncreasing polarisation and little or no growth will preclude investors from taking macro positions inthis phase of the opportunistic investment cycle. The strategy has to be highly focussed and selectiverather than taking a macro position on a particular region or sector.
Opportunity IV Value creation by asset management
Hands-on experience
Sourcing of
transactions
Credible manager
The asset manager will be the main driver of investment returns in this cycle. The manager has to havethe operating and financial expertise required to drive returns against a background of substantiallyless debt and rates of economic growth.
The ability to source transactions and leverage local relationships to achieve competitive advantagewill be critical in determining a successful opportunistic investment strategy.
The track record and credibility in the market of the investment manager is crucial not just in beingable to access debt but in reducing the level of execution risk associated with complex transactions.
Scarce resources
This mix of operating and financial experience required to drive returns is increasingly scarce followingthe turmoil of the last few years, and the impact of regulatory change which will speed up the pace ofconsolidation in the investment management industry. Those constraints on capital and operatingexperience provide an attractive environment for pro-active managers.
Entity level restructuring and public to private activity. Raising new capital is both dicult and dilutivewith equity markets remaining volatile and the majority of real estate companies trading at a significantdiscount to NAV.
Source: J.P. Morgan Asset Management
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19 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe
Footnotes
(1) Typical denition o investment styles according to the European Association or Investors in
NonListed Real Estate Vehicles (INREV).
Investment style
Core Mid risk Opportunistic
Total return
expectations68% 811% 15%+
LTV 60%
Timing Highly sensitive to
market cycle
Sensitive to
market cycle
Less sensitive to
market cycle
Market access Competitive bid Mainly ofmarket
RiskMinimal leasing risk,
lease expiries and
capex requirement
Modest leasing and
vacancy risk. May
included light
reurishment
May include
reurbishment and
groundup
development risk
Holding periodLong tem hold
(10 years+)57 years
Short tem (23 years)
with active trading
strategy
Driver o valueIncome growth
Balance between
income and capital
Mainly driven by
capital appreciation
Income driver >60% 50%
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