Sovereign wealth funds and real estate: The sovereigns are coming
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Sovereign wealth funds and real estate: The sovereigns are coming

A surge in sovereign wealth funds’ real estate activities could bring an estimated $100 billion in investments to the sector annually. However, although sovereign funds are cash rich, they won’t be throwing their money around but rather hunting for bargains. Rachel Wolcott reports.

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Sizing up sovereign investment: Forecasts for sovereign wealth funds’ investments in real estate

Sovereign wealth funds have made headlines coming to the rescue of investment banks damaged by bad real estate bets in the sub-prime mortgage market. Now these same funds are targeting real estate directly. Just as they have propped up Merrill Lynch, Citi, UBS and others, there are hopes that the funds will do the same for the battered commercial real estate sector.

Cash-rich sovereign wealth funds have trillions stashed away from surplus revenues generated, in most cases, by oil sales. Even if only a small proportion of this wealth is directed to real estate, it could mean $80 billion to $120 billion annually, according to research from Eurohypo (see Sizing up sovereign investment).

The perception that there is now value in the sector is behind a number of recent deals. However, attractive valuations in such markets as the US and the UK are only part of the reason why sovereign wealth funds are increasing their allocation to real estate or even setting the stage to make their first investments. As an asset class, real estate offers sovereigns protection against inflation as well a diversification tool. Some market observers argue that real estate gives sovereigns access to so-called alpha-generating assets without entangling them in sensitive national security issues. Historically, sovereign funds sought to acquire stability through buying bonds, and more recently looked to the equity markets for alpha generation.

"They were not interested in property," says Philippe Tannenbaum, London-based director of research at Eurohypo. "It was not a fashionable target for them. Now that they are getting closer to the point when they will no longer have oil revenues and are looking for long-term cashflows, sovereign wealth funds are understanding that property is no longer perceived as a sector where you buy an asset and you sleep on it. It is an alpha generator, which can give very high returns if properly managed and sold at the appropriate time."

On a fundamental level, sovereign wealth funds’ attraction to real estate is also part of a wider trend among global investors towards considering real estate as part of their overall asset allocation.

"More generally, international investors have now got to grips with having a global real estate investment strategy," says Chris Bartram, chairman of London-based Orchard Street Capital. "If you are a big enough player to have a property allocation, it now makes sense to play that out on a global basis."

The sovereign funds are following a well-trodden path established by institutional investors active in global real estate such as AIG, ING and Prudential. Like the institutional players, some funds have been active in their local markets and are looking overseas for new opportunities. However, there are sovereign wealth funds such as Singapore’s Government Investment Corp, the Abu Dhabi Investment Authority, and the Kuwait Investment Authority that have been active in real estate for years. GIC Real Estate has been making investments since 1982 and KIA has a direct investment arm in the shape of London-based St Martins Property Corp, which it acquired in 1974.

However it is the newcomers that have the market excited. News that Norway’s Government Pension Fund will allocate up to 5% of its $350 billion of assets in real estate has enthused market participants (see Keen but cautious interest from Norway’s sovereign fund). And China Investment Corp, worth an estimated $200 billion, is said to have set its sights on the German property market. There have been reports that CIC, possibly through an investment subsidiary, is seeking to deploy $20 billion buying up commercial property in Germany.

The Australians are also gearing up for a foray into global real estate. Australia’s Future Fund, with A$59.6 billion ($57.2 billion) in assets, recently hired Pinnacle Property Group’s Barry Brakey to develop and manage its property investments. A spokesman at the Future Fund declined to comment on its ambitions.

The Kingdom of Saudi Arabia is about to announce its plans to create a wealth fund – which some participants in the market estimate will have assets of about $900 billion; others claim it might be seeded with $5.3 billion. This fund could well prove to be another deep pool of cash headed toward the real estate sector.

When it comes to real estate investing, sovereign funds have the reputation – rightly or wrongly – for acquiring trophy assets. Although there has been some of that going on – Qatar has invested in London’s The Shard and Qatari Diar bought the landmark Chelsea Barracks, also in London – distressed and value opportunities are more attractive.

"Sovereign wealth funds are shying away from trophy assets. The theme is distressed assets"

Fadi Mousalli, Jones Lang LaSalle

Fadi Mousalli, Jones Lang LaSalle

"Sovereign wealth funds are shying away from trophy assets, or they will only buy a trophy if it makes sense from an economic point of view. The theme these days is distressed assets," says Fadi Moussalli, regional director, international capital group, for Jones Lang LaSalle in Dubai. "Even if funds are awash with cash and they need to deploy this cash in real estate investments overseas, this does not mean they will overpay for assets."

Moussalli argues that sovereign funds are conscious of the advantage they have as cash buyers. Being in the position to pay cash should put them in a position to buy properties for less than an investor dependent on bank finance.

"We’re not seeing sovereign funds going into markets that are overvalued," says Michael Cutteridge, director, capital markets at DTZ in London. "Basically, they’re looking at the globe and they’re looking for value."

Right now, the markets looking decent from a value perspective are the US, the UK and western Europe. Thanks to the credit crunch and the sub-prime crisis, commercial property values in these jurisdictions have come down sharply from their peaks and are attracting investors that had been seeking opportunities in emerging markets – particularly Asia.

Seeing signs of softness in the market, sovereign funds have already started to make their moves. The Investment Corp of Dubai has shown an interest in Inmobiliaria Colonial, the troubled Spanish property group. It recently made an offer to buy an 85% stake for about €9 billion.

Singapore’s GIC Real Estate is also targeting distressed assets – setting its sights on the UK. It has paired with London-based Orchard Street Capital to create the £300 million ($589.5 million) Special Situations Commercial Property Fund. The fund, which will have a seven-year life span, is seeking to invest in UK commercial property in all the main sectors of that market. It will target properties that can deliver mid-to-high teens total returns and has set a maximum individual property size of £50 million.

"It’s very much what we do," says Orchard Street’s Bartram. "Orchard Street has produced its past performance out of aggressively working assets by tenant engineering and redevelopment, for example. It’s a detailed execution strategy that involves properties far smaller than those GIC usually gets involved in. It sits alongside the rest of their portfolio strategies in an independent niche."

Distressed and value investing is a prominent theme at the moment but sovereign wealth funds have made and continue to make investments across a broad spectrum of assets using a variety of techniques.

Partnering with investment managers, such as GIC Real Estate has done with Orchard Street, will be a popular approach. As funds will want to invest globally, seeking out local expertise is going to be crucial to their success.

"It’s difficult, if not impossible, to fly into other cities and beat the locals," says Bartram. "It’s great if funds want to come in and team up with locals with good performance – that’s fine."

In a similar vein, sovereign funds will team up with experienced real estate companies and managers for joint ventures and co-investments. Willingness to pair with proven real estate players might come in part as a result of bitter experience.

"Some [sovereign funds] have been around for a long time and some have been burnt in the past by mismanagement," says Pierre Rolin, chief executive of Strategic Real Estate Advisors. "This time around it’s being handled by a much more professional layer of independent managers rather than family and friends."

Already there have been many permutations on co-investing and joint ventures as sovereign funds often have various investment subsidiaries, or governments themselves set up real estate companies separate from their established sovereign wealth funds.

"Indeed some of the sovereign funds’ strategy today is to act as silent financial partners for either asset managers or developers," says Jones Lang LaSalle’s Moussalli.

Singapore’s GIC Real Estate is a good example of a sovereign investor that takes a variety of approaches. In addition to teaming up with Orchard Street for its opportunities fund, it has invested $300 million in Rosen Real Estate Securities, a US property hedge fund. The fund also makes direct real estate investments, either buying properties straight out or by taking stakes in real estate companies.

A recent example of such activity has been GIC’s joint venture with US-based Host Hotels & Resorts to explore investment opportunities in Asia and Australia. Host Hotels is the largest lodging real estate investment trust and one of the largest owners of luxury and upscale hotels. Host Hotels and GIC will invest a maximum of $600 million of equity in the joint venture and use leverage to reach a total investment potential of $2 billion. Host Hotels will own a 25% interest in the venture.

GIC has also gained exposure to the Italian retail market through a co-investment with ING Real Estate. In February, GIC and ING entered into a joint venture for the acquisition of the new Roma Est Shopping Centre from Italian food-retailing leader Gruppo PAM. Roma Est Shopping Centre, one of the largest shopping centres in Italy, comprises approximately 92,700 square metres of gross lettable area.

The value of the transaction was approximately €400 million, with ING Real Estate and GIC having equal stakes in the property. ING added the property to its ING Retail Property Partnership Southern Europe and has been appointed asset manager. This way, GIC gains exposure to the Italian market and harnesses ING’s expertise in asset management.

To a certain extent, sovereign funds are following a similar path to GIC by setting up real estate subsidiaries and looking for partnerships as they seek investment and development opportunities outside their home regions. This strategy is already in evidence in the Middle East.

"In the Gulf, sovereigns have set up their own real estate subsidiaries that are either investment companies or development/investment companies to focus on local and regional projects," says StratReal’s Rolin. "That was the first wave. Now some sovereigns are investing in international investment and development projects."

Sovereigns certainly see the value in bringing in international expertise to achieve their ambitions in the real estate sector. Abu Dhabi’s government-owned Mubadala Development Company has set up a joint venture with Chicago-based real estate firm The John Buck Company. Previously, Mubadala made investments in energy, telecommunication, aerospace, automotives, healthcare, real estate and ship-building sectors at home and abroad.

The new venture, John Buck International, in which Mubadala will hold a 51% stake, marks a change in its approach to real estate development and investment. Based in Abu Dhabi, John Buck International will specialize in real estate, leasing and management services. At first the focus will be local, with an eye to international expansion.

Mubadala has also set up a $300 million joint venture with Singapore-based company CapitaLand, which will begin with a $4 billion mixed-use project in Abu Dhabi. "Through this joint venture we will turn property development ideas into reality," Mubadala said in a statement. "Our strategy of making capital-intensive investments with long-term horizons will contribute to the regeneration of property in Abu Dhabi as well as enhance the real estate sector in the emirate."

Although market repricing has created attractive opportunities in the short term, the overall impact that sovereign wealth funds ultimately have on the global commercial real estate market remains to be seen. In 2007, investment in global commercial real estate totalled $759 billion, so sovereign wealth would bring an increase in investment of 5% to 8% – not a shake-up – according to Eurohypo research.

Philippe Tannenbaum, Eurohypo

"Everyone is looking at sovereign wealth funds, but I think their immediate impact will be more psychological"

Philippe Tannenbaum, Eurohypo

"Everyone is looking at sovereign wealth funds, but I think their immediate impact will be more psychological than direct," says Eurohypo’s Tannenbaum. In other words, the mere idea that sovereign wealth funds are coming into commercial property could go a long way to improving confidence in the sector. Their ability to come in as cash buyers during this period of moribund liquidity will be welcomed. There are expectations that sovereign cash will revive transactions stuck in the mire of the credit crunch. However it is uncertain how far fund inflows and direct investment from sovereign wealth funds will go towards underpinning the wobbly UK and US markets.

"What I’d like to see is whether they are ready to invest in listed property companies," says Tannenbaum. "The impact would be much more significant if they are prepared to go into listed property companies."

Ultimately, market participants expect sovereign funds to operate in all the different areas of the global commercial real estate market – including property derivatives and listed property companies. Although sovereign funds are poised to benefit from opportunities in the markets thrown up by the credit crunch, their interest is far from opportunistic. As far as market experts are concerned, this interest in property is set to be a long-term one.

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