How Europe's next real estate cycle will be asset management led
Focus is a publication that aims to bring you face-to-face with a selection of key investment managers, advisers, and providers from across the market.
© 2023 Incisive Business Media (IP) Limited
The status quo that many real estate investors have become accustomed to over the past decade is changing. The era of cheap credit is coming to an end, and the wall of capital pushing European real estate yields lower can no longer be relied upon for returns. With the leveraged beta window now closed, the ability to reposition assets and grow income through active asset management will be critical going forward.
IN THIS EDITION
READ NEXT
However, amidst expectations of structurally higher interest rates and a significant ongoing repricing, the European real estate is starting to offer good relative value. Coupled with supply shortages in several segments, a great opportunity to generate enhanced returns is opening up in the market.
© 2021 Incisive Business Media (IP) Limited
In this guide, we explore the fund’s strategy in detail and analyse how it seeks to tackle the uncertainty of today’s market while also matching investors’ sustainability expectations.
The global pandemic has left capital markets facing radical uncertainty.
The pursuit of yield in sustainable credit
Focus is a publication that aims to bring you face-to-face with a selection of key investment managers, advisers and providers from across the institutional pensions market.
In this guide, PATRIZIA shares how they plan to harness the new real estate cycle and macroeconomic trends in European real estate to drive returns in their upcoming TransEuropean flagship fund.
Important Notes Risk Investing in the TEP funds involves not only opportunities for capital growth and distributions, but also risks. Typical risks include: Real estate risks: The Partnership's rental income may decline as a result of vacancies or insolvent tenants. Locations and properties may become less attractive to tenants, so that only lower rents can be obtained there. The properties themselves may be damaged or destroyed by fire, storm or other events. Their value can also decline, for example, due to unforeseen contaminated sites or construction defects. Maintenance may become more expensive than planned. Development risks: In the case of construction projects, completion may be delayed. In addition, the completed building may not be immediately leased or the achievable rental price may be lower than assumed at the start of construction. Investments in real estate companies: If the Partnership acquires real estate indirectly through a company/special purpose vehicles (SPV), risks may arise from changes in corporate and tax law, particularly abroad. Debt-financed properties: If properties belonging to the Partnership's assets are financed with a loan, their fluctuations in value have a greater impact on the price of the shares in the fund (so-called leverage effect). This applies to increases in value as well as to decreases in value. Special price change risk: During the holding period, the market value of the Partnership's assets and thus the price of the units/shares/interest may fall. As a result, there is a risk that the final price achieved by the investor may be lower than the issue price at the time of unit/share/interest acquisition or than the redemption price at the time of the irrevocable declaration of redemption (if any). Regulatory risk: The Partnership will be governed by the LPA and the Partnership's offer documents. The value of some investments may be adversely affected by changes in government policies, regulations and laws, including tax laws and laws affecting the Act. The actions of governments and regulators have a significant influence on the outlook for companies and the returns to investors in the Partnership. Foreign investment risk: Additional risks may arise when investing overseas, including changes in foreign exchange control regulations, foreign tax legislation and withholding tax and government policy. Additionally, differences in accounting, legal, securities trading and settlement procedures can also impact on the value of the Partnership’s investments. Liquidity of the fund's investments: Some of the Partnership's investments may be highly illiquid and difficult or impossible to sell. This may mean there are delays in redemption processing, or even the suspension of redemptions. Interest rate risk: Fluctuations in market interest rates may impact an investor's investment in the Partnership. For example, rising interest rates may increase the cost of borrowing and this may adversely affect the Partnership's ability to make timely payments in respect of any financing or debt arrangement. For detailed information on certain risk factors, please refer to the PPM. The above list is not exhaustive. Past performance disclosures Unless indicated otherwise past performance of TransEuropean Property (“TEP”) investments is shown at investment level. Investment level returns are shown after leverage, but before usual fund costs, fees, carried interest and fund level taxes, and before any individual costs at investor level such as fees, commissions and other fees, which, if considered, can have a negative impact on performance. Taxes or hedging expenses at investor level are not considered. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Investors should consider the volatility of total returns in individual years. Total returns consist of income return, unrealised and/or realised capital growth return. Dividend payments can fluctuate over time. Past performance is not a reliable indicator of future performance, and past performance information is provided for illustrative purposes only. The prior investment results of any person or entity described in this Presentation and the examples of real estate transactions contained in this FOCUS are provided for illustrative purposes only and are not indicative of the Partnership’s future investment results. The nature of, and risks associated with, the Partnership’s future Investments may differ substantially from those investments and strategies undertaken historically by such persons or entities. Disclaimer The information contained herein is directed only at professional clients and intended solely for use by the recipient. No part of this document or the information herein may be distributed, copied or reproduced in any manner, in whole or in part, without our prior written consent. This document is for information and illustrative purposes only. It does not constitute advice, a recommendation, or a solicitation of an offer to buy or sell shares or other interests, financial instruments or the underlying assets, nor does this document contain any commitment by PATRIZIA SE or any of its affiliates. Whilst prepared to the best of our knowledge, the information contained in this document does not purport to be comprehensive. PATRIZIA SE and its affiliates provide no warranty or guarantee in relation to the information provided herein and accept no liability for any loss or damage of any kind whatsoever relating to this material. The information herein is subject to change without notice. For further information on other country disclaimers please visit Product Marketing Country Disclaimers | PATRIZIA SE July 2023 PATRIZIA Institutional Clients & Advisory GmbH
Contact us
THE INTERVIEW
Name xxxxxx xxxx xxxxx xxxxxxx
For real estate investors, this presents risks but also opportunities to generate alpha. While credit is no longer cheap, valuations are lower there is a supply shortage in several market segments. Paul Hampton, Head of International Funds, and Radu Mircea, Director, Investment Strategy and Research, at PATRIZIA, share their outlook on the UK and European real estate markets and where they foresee attractive returns coming from.
he post-financial crisis environment that has defined the past cycle is changing. The UK and Europe are seeing a new macroeconomic regime defined by higher and more volatile inflation, and structurally higher interest rates.
T
Finding growth in a new economic cycle
Markets over the next 5-10 years will likely be defined by the need to invest amid tighter monetary policy. There is a political urgency to invest in the green transition, defence sector, and rebuild public infrastructure after more than a decade of under-investment. However, inflation will need to be kept under control.
has helped drive risk asset valuations ever higher despite the damage wrought by COVID-19, compressing yields and making portfolio income distribution objectives harder to achieve in both equities and fixed income.
I
A new macroeconomic regime
He believes that from an adviser’s point of view, there is a large opportunity to broaden the focus and think of cash as a strategic asset class and part of a holistic, diversified portfolio.
Cash has been an area that financial advisers have historically ignored. Yet it is an easy entry product and is easy for advisers to talk to their clients about. The opportunity here is for advisers to look at clients’ wealth holistically and offer cash as a haven with a respectable rate of return.
“There's a considerable time-versus-return barrier for people, which is why we've got that nearly £1trn sitting in current accounts earning very little,” says Merchant.
Despite the tighter access to credit, Mircea explains that Europe’s push to advance initiatives such as the green transition will contribute to a more favourable growth environment compared to the one following the Global Financial Crisis and Eurozone debt crisis.
Radu Mircea, Director, Investment Strategy and Research
Markets over the next 5-10 years will likely be defined by the need to invest amid tighter monetary policy
£1trn is invested in current accounts with High Street banks, meaning that cash is currently earning around 0.1%
Out of the £1.7trn cash that is held by individuals or households, £260bn is held in accounts that earn no interest at all
£1.7trn
How much of that £1.7trn is held in accounts that earn no interest at all
£260bn
The amount of cash that is held by individuals or households
0.1%
The importance of cash is reflected in the overall size of the cash savings market. In the UK, the market is huge. According to the Bank of England, total cash savings are £2.6trn and of that, £1.7trn is held by households. From a long-term investing and savings perspective, cash has always had a necessary and inevitable place in a diversified portfolio.
Gary Kirk, co-manager, TwentyFour Sustainable Multi Sector Credit Fund
ESG will drive asset performance, particularly among institutions that have to stand up and be accountable to their members
MENU
Strategies that worked over the past 5-7 years might no longer work in the new macroeconomic regime. Paul Hampton emphasises how a huge amount of investors came into the European real estate market due to the low cost of borrowing; the result was a huge growth in leverage and liquidity in the asset class, relying on year-on-year rising demand.
Coupled with a starting point of relative undersupply, this environment will offer good opportunities for value creation. In the office sector, for instance, a significant share of the market that has been under-invested and there's a scalable opportunity for improving those assets and futureproofing them for future tenant demand.”
It is easy to forget in the property sector that you are developing a product for someone. How well a property satisfies the occupier will determine not only the amount of income generated but its longevity.
Know your occupier
Hampton says: “Our mantra has been if you forget the occupier, if you forget who is using your buildings, you do that at your peril. That will come back to bite you.”
If the right profile of occupier wants your property, the results can be lucrative. Many companies view rent as a limited part of the equation and consider attracting quality staff as a higher relative cost. Having a desirable office could even save businesses costs in staff turnover and transportation.
To ensure their properties find the right occupiers and fill a market need, Hampton emphasises the importance of having a strong management team in place and conducting research.
In Berlin, Hampton explains that they built an investment thesis around the economic transformation of the city from being a very high unemployment grade area in the mid to late 2000s, to a booming one in the last 5 to 7 years, driven by the technology sector.
He says: “Our investment team looked at market dynamics to understand, from an urban change point of view, which were the future hot spots in Berlin and undertook bottom-up research to understand what type of office space occupiers wanted in those selected locations.”
There is also a growing emphasis on sustainability and decarbonising assets. Upcoming regulations and investor demand require the development of properties, even compliant ones, to ensure they remain up to standard.
Mircea says: “There has been a policy shift in Europe and that's going to inevitably lead to more regulation over the next 5, 10 years. Environmental, Social, and Governance are going to define the next cycle and the type of strategies we will have.”
Paul Hampton, Head of International Funds
Our mantra has been if you forget the occupier, if you forget who is using your buildings, you do that at your peril
With a new macroeconomic regime comes a new economic cycle. While investors might still be coming to terms with the challenging economic environment, there are still strong reasons to invest in the European real estate markets. Both Hampton and Mircea argue this economic cycle will be an asset management-led one.
A new cycle
Hampton concludes: “I feel the opportunity to generate returns is being under-represented. Over the next 5 years, if you've invested sensibly in some supply-constrained markets, cities, sectors, with capable asset management, growth in returns and net operating income should be eminently possible.”
With rising interest rates and inflation impacting real estate markets, where should investors look for returns?
IN_DEPTH Q&A
TEP FUND SERIES SNAPSHOT
HOME
Despite the inevitability and benefits of holding cash, it is not without risk. The most severe is inflation, which erodes the value of cash over time.
A state of inertia
In a post-pandemic world with growing market volatility and innovative new approaches to investing, thematic investing has seen a surge in demand.
Charles Tarriere, Managing Director, Fund management
CLOSE
Insight from Paul Hampton and Radu Mircea
THE interview
A proven track record of generating returns
PATRIZIA’s plans for value add investing in Real Estate
IN-DEPTH Q&A
snapshot
FUND SNAPSHOT
Committed equity
Bluebox, Geneva, office
PATRIZIA has been manager to the TransEuropean Property (“TEP”) series of funds since 1992. These closed-ended vehicles have invested across both the U.K. and Continental Europe with the aim of generating out-sized returns through proactive, thoughtful stock selection and asset management. Since Q1 2007, TEP has invested €3.5bn across 14 countries, generating a 20% IRR p.a. and an equity multiple of 1.9x on realised investments.
TEP Series: Fund overview
TEP I-III
€ 370m
Invested
€ 546m
Leverage
26 - 44%
TEP IV
€ 537m
€ 274m
47%
TEP V
The case for logistics
The case for office
Major urban areas: Scarce availability of land & competition from alternative uses (residential, self-storage, data centres etc.) limiting supply & increased demand for dense urban distribution networks bolstered by e-commerce bolstering long-term rental prospects.
London urban industrial – record high rental growth in 2021-22
€ 353m
€ 750m
Paris Oise Logistics Park, Paris
41%
TEP VI
€ 933m
€ 429m
Project Diane, various locations in France
45%
(2018-2022)
Project Urban
€ 1.1bn
€ 1,243m
Tanger 73, Barcelona, office
55% (expected)
TEP VIII
Invested (EUR)
€ 000m
Targeted equity
€ 1.5-2.0bn
1
Re-develop obsolete assets to create a portfolio of Grade A, ESG-exceptional properties
Case Study: London Urban Logistics, UK
Why?
• 90-95% of total equity raised has been committed to 7 projects • Perfect recipe for strong rental growth • Resilient demand from a broad range of occupiers
Our added value:
• Re-develop out of date stock to best-in-class ESG buildings • Struck partnership with a local operator
What have we achieved?
• £380m (€440m) invested in 7 sites • Rental growth already 10-20% ahead of plan • Market leading ESG strategy in place – all electric buildings • 61,000 ft² warehouse under construction; pre-leased for 20 years @£32/ft² (target: £25.40/ft²) • 2 buildings progressing well through permitting stage
Information as at 31 December 2022. Performance of realised investments quoted at gross investment level quoted after leverage but before fund fees, costs & taxes. Past performance is not a reliable indicator of future performance, and past performance information is provided for illustrative purposes only. 1 This is a target only and may not be achieved.
rental growth captured in 18 months
60
%
tripled rent from acquisition to sale
3
X
Place-making office re-development acquired off-market
Case Study: NIKE European HQ on Warschauer Straße, Berlin, Germany
• Since 2016, acute offer / demand imbalance • Tech occupiers driving boom of Silicon Allee • Strong rental growth prospects for "cool & flexible" buildings
• Identified & catalogued target buildings in East Berlin (primary research) • Off-market approach to non institutional landlords • Local development skills
• Redeveloped 4,500 old multi-story building + additional 4,100 m² new build • Built on time and budget • Rents negotiated: 30 EUR/m² per month vs. 10.77 EUR/ m² per month on day-1
Information as at 31 December 2022. 1 Returns are realised investment / property level returns after leverage, but before vehicle level expenses, fees and taxes. Past performance is not a reliable indicator of future performance, and past performance information is provided for illustrative purposes only.
Realised Returns:
• 65% IRR p.a. / 3.6x MOIC realised return
Large fall in industrial stock (-27% change in stock in London during 2001-2022)
London rental growth – acceleration in 2021-22
Source: Gerald Eve, VOA (LHS), PMA (RHS), PATRIZIA | April 2023
Office market fundamentals have remained more resilient in Europe, average vacancy are much lower than in the US and future supply is expected to be limited. However, the gap between well-located, high-quality assets and the rest will widen, calling for careful stock selection and proactive asset management.
Europe is different: low vacancy and limited future office supply
Net additions expected to be very low - <0.5% of stock pa
Europe is more supply constrained: low vacancy rates vs. other global markets*
Source: Green Street (LHS), JLL (RHS), PATRIZIA | May 2023 *average of 23 markets in Europe; 50 markets in the US; 22 markets in Asia Pacific.
Q2 2012 Pivoted investment strategy away from European food-led retail into distribution warehouses
Q1 2019 Commenced research to move into community-focused retail warehouse centres in U.K.
Gross IRR / EM
11.9% p.a. / 1.8x
7.9% p.a. / 1.5x
FULLY REALISED
21.5% p.a. / 1.7x
Gross IRR / MOIC (realised investments)
43.5% p.a. / 3.4x
Q1 2016 Embarked on Berlin tech-office repositioning strategy
Case Study
38% REALISED
Q2 2020 Commenced research to support move away from hub logistics towards urban logistics with €250m subsequently raised
Investment themes
8-12
1 / 2
2 / 2
Realised at 22% IRR p.a. / 4.0x MOIC
Realised at 27.7% IRR p.a. / 2.4x MOIC
Realised at 32.7% IRR p.a. / 2.3x MOIC
Realised at 17% IRR p.a. / 1.7x MOIC
Click here to view case study
Q1 2023
Last asset sold Q1 2021
Last asset sold Q1 2022
1992 - 2007
2007 - 2010
2012 - 2016
2015 - 2017
2018 - 2022
2022 - present
TEP VII
PATRIZIA has been Manager to the Trans European Property (“TEP”) series of Funds since 1992. These closed-ended vehicles have invested across both the U.K. and Continental Europe with the aim of generating out-sized returns through proactive, thoughtful stock selection and asset management. Since Q1 2007, TEP has realised €3.5bn of investments across 14 countries, generating a 20% IRR p.a. and an equity multiple of 1.9x.
Q2 2012 Pivoted Fund investment strategy away from European food-led retail into distribution warehouses
Last asset sold Q1 2023
Project Diane
43.5% p.a. / 3.2x
€ 750m + £ 250m
5
Information as at 31 March 2023. 1 Main fund (EUR) plus Project Urban sidecar (GBP). 2 TEP VII & Project Urban are >95% committed, taking into account recently drawn capital & future funding requirements. 3 Debt taken as the average LTV over the life of the Fund at the point of reporting. 4 Gross realised investment level returns quoted after leverage but before fund fees, costs & taxes. Past performance is not a reliable indicator of future performance, and past performance information is provided for illustrative purposes only. 5 This is a target only and may not be achieved.
Since 2016, acute offer / demand imbalance Tech occupiers driving boom of Silicon Allee Strong rental growth prospects for "cool & flexible" buildings
Identified & catalogued target buildings in East Berlin (primary research) Off-market approach to non institutional landlords Local development skills
Redeveloped 4,500 old multi-story building + additional 4,100 m² new build Built on time and budget Rents negotiated: 30 EUR/m² per month vs. 10.77 EUR/ m² per month on day-1
65% IRR p.a. / 3.6x MOIC realised return
• • •
• • • •
•
£380m (€440m) invested in 7 sites Rental growth already 10-20% ahead of plan Market leading ESG strategy in place – all electric buildings 61,000 ft² warehouse under construction; pre-leased for 20 years @£32/ft² (target: £25.40/ft²) 2 buildings progressing well through permitting stage
• • • • •
90-95% of total equity raised has been committed to 7 projects Perfect recipe for strong rental growth Resilient demand from a broad range of occupiers
Re-develop out of date stock to best-in-class ESG buildings Struck partnership with a local operator
• •
TEP SNAPSHOT
PATRIZIA’s plans for the next 5-7 years in real estate
€ 1.5- 2.0bn
Target return (Gross IRR / MOIC)
13-15% p.a. / 1.7x
“Rather than sending them off into ‘the wilderness’ of managing different bank accounts and trying to keep within the FSCS levy limit, Flagstone means that they can deal with it all in one place, giving them and us more control,” she says.
In Europe there is so much going on. At the moment, there are so many different directives, initiatives, labels and so on all operating at once that it can actually distract the businesses and institutions trying to implement the right changes. From my point of view, there needs to be overarching regulation that provides effective guidance to both bond investors and issuers alike.
How important are the recent regulatory changes in Europe and the US?
Market outlook
Integrating ESG:
Clients can spread money across any number of banks and receive FSCS protection of £85k (individual) or £175K (joint), each time
Accounts range from instant access to fixed-term deposits, allowing a tailored approach to client needs
Rates are constantly updated, and Flagstone’s market-leading position ensures competitive rates
Manage accounts across sterling, US dollar and euro
Secure
Flexible
Competitive
Currency options
Key factors
How the platform works for clients
Become a Flagstone client. Minimum deposit of £50K
Complete a single application to cover all deposits
Transfer deposit to your account
Choose the best savings account for your deposit from up to 50 banks
Move, place, or spread your deposits from one central hub
Enjoy FSCS protection up to limits where eligible
6
4
2
Onboarding from anywhere in the world for offshore clients through Flagstone International*
Global reach
Control
Clients have 24/7 access and immediate visibility and control of money
Holistic view
Access to consolidated information across all cash-deposit accounts, including a single tax certificate at year end
*Launching Q4 2022
We believe it's essential for investors to realign their portfolios to the transition in order to safeguard future returns
Thomas Hohne-Sparborth head of sustainability research
Simon Merchant, co-founder and CEO
With a market repricing not seen since the global financial crisis, Charles-Nicolas Tarrière, Managing Director, Fund Management, PATRIZIA explores how they are planning to take advantage of this new cycle in their upcoming real estate fund.
The series of TEP funds started back in the early 1990ies. What connects them together is the team (the current one has been in place working together for more than 17 years!) - a real differentiator to our competitors. Without the people behind the fund, you cannot drive the performance.
Could you give me an overview of the PATRIZIA TransEuropean Property (TEP) fund and their philosophies?
The second thing is what we call our investment philosophy. We call it "Income and Growth" investment strategy. When we approach the market, whatever cycle we're in, we always try to create two buckets in the portfolio. For the "Income " bucket we buy properties that have been neglected by their current owner but where we can grow the underlying cashflow through active management. This cashflow is systematically distributed to our Investors and creates a "bedrock" of returns for their commitment. We buy properties that deliver a day 1 income cash flow and can be managed to grow that income to distribute to our investors.
We then combined these with growth assets, which are much higher-octane returning, more capital-led type of investments. These are properties where you need to go a bit deeper in terms of their repositioning. For instance, repurposing a building and ultimately making it fit for purpose.
The funds have been growing. They've usually been growing by about 30-40% every time. The last fund and co-investment opportunity raised €1.1 billion. The new fund, TEP VIII, we're targeting €1.5bn to €2.0bn
First, is the market cycle opportunity. There is a repricing that started 6 to 12 months ago. It's continuing and is going at a different pace in Europe too. The last time we saw such a repricing was just after the global financial crisis.
While the overall macro position is a bit different from 2008, what fills me with confidence is that the property industry is in a much healthier position. Back in 2008, there was an oversupply of square meterage in Europe generally, but now there isn’t enough supply, especially good quality stock.
The second thing is it's going to be a cycle for the next 5 years minimum where returns are going to be driven by asset management, which is what we are strong at. It's not going to be simply waiting for the market to appreciate year-on-year. You will have to work hard for it to deliver the returns.
What is different with TEP VIII?
Absolutely, in the UK there's a general lack of new quality assets and modern buildings. For instance, if you look at future minimum EPC regulations, the UK is leading the charge in Europe. Yet around 70% to 80% of office stock in London would be out of date and not comply with the energy requirements by 2027. That’s 70% to 80% of the stock that will basically be unlettable and unsaleable; there’s an enormous amount of demand to redevelop these properties.
We've also seen that when you develop properties that are fit for the market and provide something more, you can drive rents up. There is evidence today that a fully singing and dancing property that has been repositioned will carry a higher rental value. With some of our properties, we've been able to drive rents by 50% or 60% in just a couple of years.
Berlin is a good example of how we called the market. Roughly 6 years ago we embarked to buying offices located in the eastern part of Berlin, an area at a time when not that many office players were buying. We saw the trend whereby companies were trying to find locations in Europe where they could get access to the workforce they wanted.
Could you give me an example?
Working with our research team, as well as our strong local team in Berlin, we interviewed media and tech companies, asking them why they wanted to be in Berlin and the type of properties they were looking for. They wanted part of the city which was cheaper, which had a better lifestyle, and where they could attract the type of staff that they wanted.
We ended up buying several buildings in Berlin. For one of them, for example, our local team managed a completed refurbishment and upgraded the building to the highest ESG standards and managed to double the size of the building. We ended up letting the whole building to one of the five worldwide headquarters for NIKE. In the process that obviously drove returns, we tripled the rent.
We've been working together for a long time. We've learnt from our mistakes, I believe. Therefore now we have sufficient experience to decipher a good from a bad trend. We also rely heavily on our teams on the ground and use our own team to invest. We speak to our people who have been living 10, 20, and 30 years in the areas and who can qualify on one street to another.
What differentiates your team and your expertise from the industry?
The third part of the equation is our research. Our Investment Strategy and Research team help us understand the megatrends and the macroeconomic drivers and assess sector-level dynamics and pricing. We also have an in-house group of data scientists who develop proprietary Big Data tools to support our strategies, for instance with underwriting and submarket selection.
We are always looking to refine our approach. We might carry over some strategies that worked in prior funds into a new one or decide they might not work anymore. With our TEP funds, it's always an evolution, not a revolution.
Charles-Nicolas Tarrière, Managing Director, Fund Management
The last time we saw such a repricing was just after the global financial crisis
We buy properties that deliver a day 1 income cash flow and can be managed to grow that income to distribute to our investors
The series of TEP funds started back in 1991/1992. What connects them together is the team (the current one has been in place working together for more than 17 years!) - a real differentiator to our competitors. Without the people behind the fund, you cannot drive the performance.
With falling real estate prices in the UK, are redeveloped/new properties still in high demand?
