FOUR QUADRANTS
SPECIAL REPORT
CAPITAL ADVISORS | MARCH 2014
INTRODUCTION
3
OVERVIEW
There is no doubt that the UK economy ended 2013 in much better shape than it started
the year. The preliminary estimate of GDP for 2013 showed growth of 1.9% for the full
year compared to a consensus forecast of less than 1% at the start of the year, and it was
striking how quickly economic debate shifted from ‘triple-dip’ recession and the damaging
effects of austerity to potential housing market bubbles and interest rate rises.
While the official statistics have been strong enough to
take most commentators by surprise, survey evidence has
been even more upbeat. A variety of surveys have been
suggesting growth well in advance of what has actually
been reported – a sure sign that the recovery has been
led by rapidly improving sentiment. There is no better
example of this than the Economic Sentiment Survey
produced by DG ECFIN. In December 2012 this survey
was reporting confidence 5% below its long-run average,
by December 2013 this measure was 13% above
the series average. With improved confidence comes
increased risk appetite, as demonstrated by a recent
Deloitte survey showing the majority of CFOs believe
now is a good time to take more risk.
This attitude is not limited to the CFOs of large corporates
however. Those with funds to invest now also appear
more willing to take on more risk, especially in the current
environment of low returns available from traditional
safe investment choices. This has significant implications
for both the direct real estate market and for all four
quadrants of the real estate capital universe.
It didn’t take long for the first signs of economic recovery
to feed through into commercial property values.
Following 18 months of values drifting downwards they
returned to growth in the second quarter of last year
and have been building momentum ever since. The vast
majority of this has been the result of yield compression
as investor appetite for UK commercial property has
returned, and it has not just been prime property that has
benefitted.
This performance was also reflected in equity markets,
with the FTSE 350 real estate sector index outperforming
wider equity indexes, a trend that has continued into the
start of 2014. Also, within the listed equity space the
pattern of returns has been changing. In particular, the
small capitalisation names markedly outperformed the
sector as a whole in 2013, in part due to the willingness
of investors to look outside of London.
Another sign of improving confidence was the significant
increase in private equity raised by UK funds in 2013.
Capital does still seem to be focussed on core strategies,
although there has been a slight uptick in interest from
capital seeking returns from value-add strategies. As in
the primary placement market, volumes transacted in the
secondary market also increased sharply, and there was a
shift in focus from the sell side to the buy side during the
year.
New issue CMBS was a theme many didn’t expect in
2013, but as it emerged it wasn’t just limited to core
areas either. Investors are now prepared to move into
higher risk, less creditor friendly jurisdictions to seek their
required returns.
It was also a year in which we saw a significant number
of new lenders and institutions become active in the
lending market. Pricing for senior lending has tightened
significantly in the past 12 months and leverage has
increased. There are a number of players who currently
will underwrite whole loans at 80%+ LTV.
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FOUR QUADRANTS
In the first of a quarterly series, CBRE Capital Advisors examines the relative pricing and performance of different
ways of accessing real estate returns using the divisions between public and private markets and debt and equity as a
framework. In an environment of recovering confidence, liquidity and physical asset values, physical property, listed
and private equity have been appreciating. At the same time credit spreads have been coming in and lending terms
have been easing. But, on the back of rising gilt yields term fixed rate debt has been falling in value.
4
DIRECT PROPERTY
Returns from direct property generally exceeded expectations in 2013. At the start of 2013
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months of the year. However since then values have seen a marked turnaround, and in
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earlier. As a result, UK All Property recorded a total return of 10.5% in 2013 according to
the IPD Quarterly Index.
The improvement in the economic situation has begun
to feed through into occupier markets. This is reflected
in CBRE’s Quarterly Prime Rents and Yields data; out
of more than 1,000 locations monitored, rents were
increasing in just 30 cases at the end of 2012 but a
year later this figure had reached 120. Despite this
improvement however, it is investor sentiment, rather
than rental growth, that is driving capital value growth
at present. As we have long suggested, an end to rental
declines rather than widespread rental growth has been
sufficient for yield compression to begin.
equity since the financial crisis but it is likely that debt
availability will improve over the coming year and the role
played by debt will gradually increase.
2013 was a very strong year for commercial real estate
investment in the UK, with £53bn transacted, only £3bn
short of 2007 volumes. In stark contrast to 2007 though,
only 26% of transactions were funded by debt against
72% in 2007. There has been a clear trend towards
We are also beginning to see investor demand broaden,
across sectors, geographies and asset quality. As a
consequence, yields are hardening across the board. In
Q4 yields compressed in all ten of the IPD property types
and the CBRE Monthly Index showed both prime and
secondary yields falling. In fact secondary yields fell more
quickly than prime yields in each of the last three months
of the year, something that has not happened since mid2011. As a consequence the prime-secondary yield gap
shrunk by 34bps, although at close to 500bps it remains
wide by historic standards. We expect this gap to continue
to shrink throughout 2014.
CHART 1: PROPERTY INVESTMENT CLOSE TO 2007 LEVEL
TREND TOWARDS EQUITY CONTINUES
£58bn
transacted
in 2013
UK Commercial Property Investment, £bn
Debt
Equity
70
60
50
£bn
40
30
20
10
Source: Property Data, CBRE Research
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
0
2001
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Source: CBRE Monthly Index
Dec -11
Oct - 13
Dec - 13
12
11
9
5
8
4.5
7
6
4
5
3.5
4
3
Yield Gap %
Yield spread falls
Aug - 13
CHART 2: PRIME-SECONDARY YIELD GAP FALLS IN Q4
June - 13
Apr - 13
Feb -13
Dec - 12
Prime vs Secondary All Property Yields
Oct -12
Aug - 12
Prime
Jun - 12
Apr -12
Feb - 12
Spread (RHS)
Oct -11
Apr - 11
June -11
Apr - 11
Feb -11
Dec - 10
Oct -10
Aug - 10
June -10
Apr - 10
Feb -10
Dec - 09
Oct -09
Aug - 09
June -09
Apr - 09
FOUR QUADRANTS
Yield %
5
f
34bps
Secondary
6
10
5.5
6
PUBLIC EQUITY
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The listed real estate markets had a very strong 2013 with the FTSE 350 real estate sector
index producing a total return of 17%, outperforming wider equity indexes. This despite
10 year gilt yields rising from 2.0% to 3.0% over the course of the year. Share prices, at an
index level, stand at a premium to last reported EPRA net asset values (“NAVs”) with only
Hammerson and Intu still at a discount among the major names. Factoring in the mark-tomarket on derivatives and bonds the premium further increases the implied pricing of real
estate in the listed equity market relative to physical asset valuations.
This outperformance of wider equity markets is a
continuation of the pattern of recent years with real estate
equities now outperforming over one and three years and
since the market low in March 2009.
What has changed has been the pattern of returns
within the listed equity space. The London specialists
have been outperforming since mid-2010 reflecting the
outperformance of London real estate as a whole. This
pattern is mirrored in the performance of the major listed
names with a higher proportion of assets in London.
However, this phenomenon seems to have been running
out of steam in 2013 with a more modest outperformance
of the sector index of 4% compared to 355% since
the market low in 2009. More striking has been the
outperformance of the small capitalisation names which
outperformed the sector by some 38% during the year.
This is a pattern that began in mid-2012 following an
essentially flat two and a half years. Given the make-up
of the portfolios underpinning these names this led, and
now reflects, the return in risk appetite for more secondary
property.
CHART 3: REAL ESTATE OUTPERFORMS WIDER EQUITY MARKET
17%
Indices, since 2009 market low
Real Estate
FTSE 100
7
index total return
FTSE 350
f
240
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220
200
180
160
140
120
3/6/2013
3/6/2012
3/6/2011
3/6/2010
3/6/2009
100
Source: CBRE Monthly Index
CHART 4: SMALL CAPS OUTPERFORMING MAJORS
Small caps
outperfom by
Indices, since 2009 market low
Majors
London Specialists
38%
Small Caps
700
600
500
400
300
200
Source: CBRE Monthly Index
Since the year end real estate equities have performed
strongly, again outperforming wider equity markets during
both the initial rally and the more recent correction.
3/6/2013
3/6/2012
3/6/2011
3/6/2010
3/6/2009
100
8
PRIVATE EQUITY
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returning to the UK real estate market. Fundraising remains competitive for managers
trying to raise for a fund and the marketing and closing period remains long. Capital
still seems to be focussed on core strategies and a few established managers. Although,
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properties, there appears to be a slight uptick in interest from capital seeking returns
from value-add strategies.
Reflecting the primary placement market, the volumes
transacted in the secondary market though PropertyMatch
increased 40% in 2013 compared with 2012. During the
year there was a shift in focus from the sell side to the buy
side with discounts to NAV reducing or shifting to slight
premiums. Blackrock UK Property Fund, a balanced fund,
traded at the start of the year at a 1.85% discount to NAV
(price per unit 33.05) and at the end of the year traded
at a 1.25% premium (price per unit 34.84). The pricing
improvement was more marked for Hercules Unit Trust, a
specialist retail fund, which traded at the start of the year
at a 10.5% discount to NAV (price per unit 594.28) and
at the end of the year at a 2.7% discount (price per unit
623.09).
In summary, 2013 was characterised by improving
sentiment, increased demand, rising prices and greater
investor appetite to risk.
9
PUBLIC DEBT
f
500
Number of transactions
Upgrade
fewer downgrades
Downgrade
1200
1000
sq ft
800
600
400
200
2013
2012
2011
2010
0
Source: CBRE
New issue CMBS was the theme of 2013 which many didn’t expect with €8.7bn (source:
Deutsche Bank AG) of originations in the European market. Whilst still far off the peak
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expect to see this further built upon in 2014 with a broadening investor base establishing
itself. Most of this new issuance was pan-European, and a clearer picture of the market
comes from looking across Europe, rather than the UK in isolation.
Whilst the demand for German multi-family exposure has
continued to remain strong, it has been encouraging to
see new issue CMBS in what could be considered more
peripheral areas such as the Italian real estate market.
This is indicative of investor demand, now prepared to
move into higher risk, less creditor friendly jurisdictions
to seek their required returns. Whilst regulatory concerns
will continue for many potential CMBS investors, relative
pricing on CMBS still looks attractive compared to
other ABS products. As an example the recent GALRE
2013-1 first pay pricing was a 225 basis points margin.
Whilst demand is steadily growing, the liquidity from
the originating banks still needs rebuilding for a healthy
CMBS market to fully return.
In the absence of significant new primary issuance, pricing
has continued to tighten in the secondary CMBS markets
with first pay pricing on legacy deals now at circa 165 bps
above Libor up to circa 425 bps on fourth pay tranches
(source: Bank of America Merrill Lynch). This is reflective
of both increased investor appetite and a strengthening
real estate market. This is well illustrated by the propensity
of the rating agencies to now upgrade rather than just
downgrade deals.
Pricing does, however, vary and we still see a trend of the
best assets refinancing at loan maturities with the weaker
2007 vintage loans continuing to suffer losses from
enforcement or extensions. German and Italian legacy
CMBS loans are maturing at a fast pace in 2014 and we
expect to see the volume of liquidations start to increase
as the broader real estate finance continues to reenergise. Liquidations from CMBS can also be expected
in the UK, with many servicers and lenders continuing to
take advantage of market conditions to beat valuations
and enhance recoveries to bondholders.
FOUR QUADRANTS
CHART 5: RATING AGENCIES SHIFTING TOWARDS UPGRADES
S&P RATING
10
PRIVATE DEBT
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PRQWKV$FURVVWKHPDUNHWÀQDQFLQJDSSHWLWHUHPDLQVVWURQJHVWIRUSULPHRIÀFHDQGUHWDLO
assets, with lower average interest rate margins offered than the overall market level.
Leverage has notably increased, there are a number of players who currently will
underwrite whole loans at 80%+ LTV.
We envisage pricing will tighten further but not significantly –
we could see prime central London at circa 60%-65%LTV
going as low as 130bps margin. Regional transactions
will be circa 100bps wider at 250bps or above. This
pricing assumes loan size of £30m and above. For
loans below £30m the UK players are becoming more
competitive, however this is still on a selective basis with
the focus being on banking clients they want to build a
long term relationship with, strong stabilised assets and
only non-speculative developments.
CHART 6: EVOLUTION OF PROPERTY FINANCING COST IN THE UK
TOP QUALITY REAL ESTATE AND TENANT
120bps
11
fall in margin, Oct – Oct
Margin
Sterling 5-Year Swap Rate
f
8.0
7.0
FOUR QUADRANTS
6.0
%
5.0
4.0
3.0
2.0
1.0
Sep-13
Mar-13
Sep-12
Mar-12
Sep-11
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
Mar-06
Sep-05
Mar-05
Sep-04
0.0
Source: CBRE Research, Macrobond
CHART 7: NEW ENTRANTS
EUROPE - FOCUSED REAL ESTATE DEBT FUNDS IN MARKET
No. of Funds Raising
17
funds raising debt
Aggregate Target Capital ($bn)
18
17
16
14
$ bn
12.4
12
12
10
8
6
4
6
6
2.9
8
7
5
2.8
3.6
2
4
7.9
3.4
2.6
1.1
Source: Preqin
Aug-13
Feb-13
Aug-12
Feb-12
Aug-11
Feb-11
Aug-10
Feb-10
0
12
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There has been an increased appetite for regional deals
from lenders but it is primarily geared towards the bigger
cities. It has been reported in 2013 that GE Capital Real
Estate provided a £130m five-year senior loan to finance
Blackstone’s St Enoch shopping centre in Glasgow at a
margin of 300bps over three-month LIBOR, reaching
circa 70% LTV, beating the 10 strong competition quoting
terms on the asset.
As senior “stretch” debt becomes the norm, mezzanine
lenders are resorting to underwrite whole loans with a
view to syndicate the senior portion. There is still a very
strong appetite for Central London deals, but due to the
fact there is a limited deal flow and many acquisitions
are closed in all cash, lenders are increasingly going up
the risk curve and looking at secondary assets many with
asset management requirements.
13
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FOUR QUADRANTS
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CONTACTS
FOUR QUADRANTS
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For more information regarding this report please contact:
Graham Barnes
Senior Director
Corporate Finance
t: +44 20 7182 2516
e: graham.barnes@cbre.com
Nuala Conneely
Analyst
Debt and Structured Finance
t: +44 20 7182 2979
e: nuala.conneely@cbre.com
Paul Lewis
Senior Director
Loan and Special Servicing
t: +44 20 7182 2871
e: paul.lewis@cbre.com
Eleonora Pulci,
Director
Debt and Structured Finance
t: +44 20 7182 2918
e: eleonora.pulci@cbre.com
David Inskip
Associate Director
EMEA Research and Consulting
t: +44 20 7182 2871
e: david.inskip@cbre.com
Rod Lockhart
Director
Investment Advisory
t: +44 20 7182 2956
e: rod.lockhart@cbre.com
GLOBAL RESEARCH AND CONSULTING
This report was prepared by the CBRE EMEA Research Team which forms part of CBRE Global Research and
Consulting – a network of preeminent researchers and consultants who collaborate to provide real estate market
research, econometric forecasting and consulting solutions to real estate investors and occupiers around the globe.
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