THE REAL-ESTATE market in Europe is flourishing. Investment banks have cut back teams in many asset classes but in real estate are still hiring. For example, in September Nomura created its first real-estate finance team, with the poaching of CSFB’s two heads of real-estate finance – Gary Wilder and Derek Vago. It has since hired two more bankers, and is bringing the group’s first securitization to market.
Lehman Brothers has also made some recent hires to expand its real-estate team in Italy and France, and has moved bankers from other parts of its fixed-income business to focus on real estate. Three years ago Lehman had 12 people working on European real estate. Now it has around 60. “Real estate is one business that is still looking rosy,” one vice-president says.
These appointments are part of a wider growth in the number of professionals working in European real estate. One of the biggest European real-estate conferences – MIPIM in Cannes – had around 7,000 delegates in 1997. Last year, in March, more than 15,000 attended. Many represented opportunity funds from the US or farther afield. One big reason for this swelling of the ranks of real-estate bankers is the expectation of what Nomura’s Gary Wilder calls “a large transference of assets from corporates to investors”.
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In the US, the commercial real-estate sector is 70% owned by investors, through REITs, and only 30% by corporates. In Europe, corporates own 80% of commercial real estate, and investors just 20%. The theory is that the European market will soon go the way of the US. In investment banking terms that means “masses of deals”, as one head of real estate puts it. With the US REIT market in a slump, many US pension funds are underweight in real estate, so are looking to Europe for supply. Banks and specialist investment funds are gathering like crocodiles on the banks of the Serengeti, waiting for this mass migration of assets, looking to snap up bargains.
Corporations can divest themselves of real estate in different ways: they can do a true-sale securitization, a synthetic lease (these were popular in the mid-1990s) a straight sale or a sale-leaseback.
The most popular current type of corporate deal seems to be the sale-leaseback, which is an easy way for over-leveraged European companies to reduce or service their debt levels, when the bond market is difficult to enter.
UK retailers Marks & Spencer and Iceland, hoteliers Thistle Hotels and Hilton have all done sale-leaseback deals this year.
Other companies said by bankers to be planning such transactions in the near future include Endesa, the cash-strapped Spanish electricity company, which recently promised to reduce its debt levels through e6 billion of asset sales; Metro, the German retailer, which has a real-estate portfolio of around e2.8 billion; and Deutsche Telekom, said by one head of real-estate finance to be in the final stages of a sale-leaseback transaction.
The trend is expected to spread from Europe to the US and Asia. For example, when Teskid, a subsidiary of Fiat, bought a metallurgy factory in Alabama recently, it sold it to CRIC Capital for $20 million, then leased it back. Teskid probably learnt the trick from its parent, which raised around $460 million in 1999 through a sale-leaseback deal with Morgan Stanley.
Sale-leaseback transactions give corporations more ready cash than the other popular method of releasing funds from real estate – securitization, a strategy that such companies as Canary Wharf have followed. The downside is loss of management control over the assets. However, banks have worked hard to increase contract flexibility on recent sale-leaseback deals.
For example, in the UK pub sector Laurel Pubs is undertaking a sale-leaseback deal of its 606 managed pubs, which it is selling to Nomura and London & Regional Estates for about £300 million ($468 million). Gary Wilder, Nomura’s co-head of real-estate finance, says: “We’ve seen the securitization of tenanted portfolios. Now, we think the managed sector is releasing value through sale-leaseback deals.”
Enhanced flexibility
Wilder stresses that new sale-leaseback deals build much more flexibility into the contracts for borrowers than similar deals in the past. “We build in significant safeguards to the way the leases are structured, so flexibility remains with the operator,” he says. “For example, they have the right to walk away from particular properties if they become obsolescent.” The securitization route for corporates remains popular too, however. Wilson Lee, European head of Lehman Brothers’ global real-estate finance team, says: “There’s definitely growth on the securitization side of the business, with corporations finding it difficult to raise money on the traditional bond and equity markets at present.”
Securitization seems to be a popular way for opportunity funds to exit from real-estate acquisitions from sale-leaseback deals. For example, Lehman is launching the securitization of e1.1 billion of real-estate assets that it and Italian real-estate fund Beni Stabili bought from and leased back to Telecom Italia in 2001.
Banks and opportunity funds are also hoping governments will be another source of real-estate assets, either sold or securitized. European governments are increasingly looking to real-estate portfolios as a way to reduce external debt and meet their Maastricht Treaty debt ratio requirements.
The main source of business for bankers will be the Republic of Italy, which told Euromoney in August of its plans to sell or securitize most of its real-estate portfolio – estimated by one treasury official at around e1.3 trillion – through an off-balance-sheet company called Patrimonio. Italy has already done some of the biggest commercial real-estate securitization deals, such as the e2.3 billion Società per la Cartolarizzazione degli Immobili Pubblici deal, led by Lehman Brothers’ real estate finance team.
The expectation of all these government and corporate deals is driving a lot of investment into real estate, particularly into opportunity funds and German open-ended retail investor funds. US capital is looking for bigger returns abroad than it can get at home, and some opportunity funds are touting annual returns of around 20% on European investment.
Opportunity funds are a good way for foreign capital to invest in property without having to pay the corporation tax levied on investment in listed real-estate companies. This is also one reason investment in direct real estate is rising, while UK-listed real-estate companies are trading at a 34% discount to their net portfolios (see graph).
Some opportunity funds and foreign real-estate investors are taking advantage of this heavy discount – for example, UK commercial property company Haslemere was bought earlier this year by a consortium including Lehman Brothers Real Estate Partners, and Brack Capital, an Israeli real-estate investor.
All this activity is keeping the real-estate teams at investment banks busy. Morgan Stanley remains the real-estate investment bank par excellence, combining its own big opportunity fund – MSREF – as well as the leading commercial real-estate securitization team, and the top M&A advisory team.
The different parts of the business work well together. For example, the debt team will securitize property bought by the opportunity fund, or the M&A team will advise MSREF on sales of real-estate assets, as it did this year with the sale of the Zeus Paris Bercy offices in France. Lehman, Goldman Sachs and Citigroup have a similar business model – with an opportunity fund and an investment banking team. Nomura and Royal Bank of Scotland have chosen to focus on mezzanine and senior debt financing, rather than equity, because of the risk appetite profiles of their banks.
The only problem with the sector is that there may now be an excess of capital chasing opportunities relative to future deals.
Many of the bargain deals, which could bring returns of 20% or more, may have already been done. Take Beni Stabili and Lehman Brothers’ acquisition of Telecom Italia’s real estate in 2001. TI was desperate for quick cash, and prepared to accept low prices. The market assessment is that Beni and Lehman made a killing. One analyst says: “The assets were obviously undervalued.” This was in part because of TI’s pressing need, and partly because the real-estate market was then even less transparent than now, so TI perhaps did not fully realize the value of its assets. The consortium’s combination of foreign capital and local knowledge helped them capitalize on this.
There may still be a few such real bargains. One investment bank’s head of real estate cheerfully says: “The real-estate market is quite dysfunctional. It’s not that transparent, so there’s still a lot of opportunities.” But they will become harder to find. As John Freedman, real-estate analyst at UBS Warburg, says: “It’s going to be a lot harder for opportunity funds to generate 20% annual returns when we’re in a falling market. There’s a lot more money looking for a home than there are homes.”
For example, looking at the three sale-leaseback deals tipped for the near future – Deutsche Telekom, Metro, and Endesa – only Endesa seems in a hurry to sell. Deutsche Telekom transferred e15 billion assets to a special purpose vehicle (arranged by Morgan Stanley) back in 2000, but still hasn’t done a big real-estate sale. Deutsche Telekom’s head of capital markets, Yorck Von Reuter, when asked if he is indeed in the final stages of the sale-leaseback deal as one real-estate bank suggested, says: “The banks are trying to force our hand! Every year there are rumours like this. We will sell when we are ready.”
Metro likewise set up an SPV in 1999 for its real-estate portfolio (arranged this time by WestLB). But a source says: “We’re not in a hurry. If we get the right price, we’ll do a deal. If we don’t, we won’t.”
Corporates, in other words, are a little more canny as to the value of their real-estate assets, particularly when so many bankers are now calling to see if they are interested in doing leaseback transactions.
There are not many obvious deals left on the listed real-estate market either, even with the 34% discount. Some of the names mentioned as possible acquisition targets – Great Portland Estates, or even British Land – will be hard to buy because shareholders appear to believe in their long-term future.
And the governmental source of supply may not be such a rapid windfall. Italy’s fabled bureaucracy or its unions (or for that matter Eurostat, the EU accounting office) may have spanners to throw in the works. And even if Italy does start unlockiing value, as one analyst says: “The quality of the assets is not institutional grade. It’s mainly smaller, older, non-prime locations. We’re not talking City of London here.”
The growth in the number of real-estate funds has meant more competition, more transparency – and lower returns. The transfer of assets from corporates to investors will happen – but perhaps more slowly than predicted. In the meantime, opportunity funds will have to scrabble for deals, and corporate CFOs can expect a lot of phone calls.
