From equities and debt to commodities and credit, the financial world is a scary-looking place for investors. Plenty of black spots can be found in real estate: everyone knows about the problems in US residential markets that helped trigger cross-asset-class deleveraging and risk aversion. The same mortgage market distress can be found in the UK and Spain, while offices have been feeling the pain for some time and there are growing indications that retail property is also set to suffer as consumers rein in their spending habits.
It’s not all doom and gloom, though. Without trying to downplay the severity of the present conditions, some market participants are already looking to the future. "The mood among investors is one of caution and uncertainty. But it should also be one of future opportunity," says Kiran Patel, global head of research, strategy and business development with Axa Reim in London.
Patel is speaking from experience. In December 2001, Axa Reim launched an opportunity fund that invested in speculative office developments in France. It was a tough sell: three months after the September 11 terrorist attacks in the US there was strong aversion to towers, interest rates were dropping like stones, and confidence generally was low for occupiers and investors alike. "It seemed like the worst time to be launching a real estate opportunity fund," says Patel. "But, in hindsight, the time to do these things is when conditions are really bad."
The fund invested close to €1 billion in French office developments over the following four years and began to sell out in 2006, closing last year and delivering investors returns in excess of 20%. A second, similar fund that has still to mature looks on course to achieve the same success.
Of course, it takes luck – and courage – to catch a market at its low point, and in Patel’s opinion that point hasn’t yet arrived at this phase of the cycle. Unlike previous down cycles in real estate, the present stress was not caused by oversupply, he says – instead, it was prompted by a glut of cheap money, which emboldened buyers and resulted in unrealistic prices and too much leverage. "That is the source of the pain and is what now has to unwind. As a result, the demand side will be affected, but we see that as a lagging response. Although you’re not seeing it today, in our view it’s about to come, and its effects will be felt more in 2009 than this year for real estate," he says.
 |
|
"Our message to clients is – if we advise you to do something, do it now – don’t wait"
Kiran Patel, Axa Reim |
More positively, Patel says that pricing has already begun to adjust to more straitened times and by the time that demand has been throttled back, prices might already be low enough to present fairly diverse opportunities: "We are telling our investors that there is no hurry to get in but to start phasing some money into real estate from 2009 onwards. They shouldn’t be ploughing everything in at once but if they’re thinking about being fully invested by 2011, that looks like a good position to be in – and you’ve got to be in the market to see the deals, to take advantage."
Patel sees high-end retail space in prime, capital city shopping locations as a good opportunity. He argues that pricing has already adjusted for these properties and they might represent good value for investors willing to take a long-term view. "For example, operate in the core space – key high street locations – the most recognizable names being Oxford Street, Regent Street, the Champs Elysées – they are core assets and now is the time to pick them up if you can, subject to vendors being realistic on current pricing. You will walk away with maybe low-single-figure returns in the short to medium term but they will prove their worth in the next boom, and in that environment everybody wants to be in those locations."
Real estate distress hasn’t stopped Axa Reim from buying, says Patel. Up to the end of May, the company had completed 60 deals for an aggregate volume of €2.8 billion. A further 25 deals worth €1.6 billion were in the pipeline, and the company had been sellers in 100 deals, worth €1.5 billion. In 2007, it acquired €5.7 billion and sold €3.9 billion, but Patel says this year’s activity shows that the company is not sitting on its hands: "We don’t need to have volume growth every year – it’s about staying active. It shows we are still in the market, it shows Axa Reim still has a huge presence, so vendors who are out there are coming to us because they know we are serious players, they know we have a variety of mandates, and that’s appealing."
As an example, one of Axa Reim’s recent deals involved the firm acquiring a portfolio of 57 hotels from Accor (eight of which are still to be developed) in a hefty €470 million transaction. Accor will continue operating the hotels, leasing the properties from clients represented by Axa Reim, which looks after the portfolio from a fund management perspective, approving budgets and managing cashflows. "We call it a sale-and-manage operation. Accor wanted the properties off its balance sheet, but still wanted to be the manager of the hotels," says Patel.
Interesting deal
Raising the finance for a portfolio of that size was not easy. Four banks were involved in the deal – BNP Paribas, Calyon, HSBC and Natixis – and as the markets moved around, terms had to be negotiated several times, says Patel. In total, it took about three months to pin down. "We were talking about hotels that are spread over France and Switzerland, so you have two different territories; one is part of the European Union and the other isn’t, so there were those issues to deal with. The hotels all had different structures and management contracts so there was a lot to go through. But we think it’s a very interesting deal and was worth the time and effort. Given the size of the deal, Axa Reim was also able to offer co-investment opportunities," he says.