Capital Advisors
FOUR QUADRANTS
Q4 2015 & OUTLOOK 2016
OPPORTUNITY AMID VOLATILITY
PUBLIC EQUITY
Affected by wider
market volatility
PRIVATE EQUITY
Sustained investor
appetite
PUBLIC DEBT
Limited new issuance
PRIVATE DEBT
Debt available,
pricing stable
INTRODUCTION
RELATIVE VALUE IN THE FOUR QUADRANTS
“It’s the end of the world as
we know it, and I feel fine.”
Really?
Perhaps “the end of the world” is a bit strong.
But for parts of the capital markets, the start to 2016
has been bleak. Sharp falls in global equities, starting
in China but spreading to other equity markets, and
the flattening in yield curves following the muchanticipated rise in official US interest rates prompted
some very pessimistic commentary from high profile
finance officials and analysts. Uncertainty is the word
of the moment.
Despite this backdrop, many UK and European real
estate investors might be forgiven for feeling fine.
In the world of real estate, the signals are almost
all positive. The final quarter of 2015 saw strong
transaction volume across all sectors. Yield
compression was a feature in many European markets
towards the year end and although UK yields appeared
to be stabilising, UK rents are rising. Falling vacancy
rates in Europe may signal a similar rental trend in
prospect on the continent.
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In most markets the supply pipeline remains constrained
by tight financing conditions for developers, mitigating
the common mid to late-cycle problem of impending
oversupply. Even beyond the real estate market,
economic growth data in the UK suggests a strong
economy, while European data, while lagging the UK,
is generally benign.
In the face of these trends, the real estate capital
markets show mixed signals. Unsurprisingly, the REIT
market reflects the equity market weakness with many
REIT stocks trading below NAV. The CMBS market has
been subdued with new issuance down noticeably in
the last quarter after margins rose. In the secondary
real estate funds market, volumes have gone up and
pricing for European core product remains firm.
But secondary pricing for some markets and sectors
has noticeably softened.
But as this issue of Four Quadrants suggests, while
times of uncertainty and volatility demand greater
focus and stronger discipline, they can also present
interesting opportunities.
So which is it; the end of the
world or a time to feel fine?
Probably neither.
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THE FOUR QUADRANTS HIGHLIGHTS
1. Public Equity
2. Private Equity
••In a period of widespread nervousness, equity
markets were predictably volatile.
••European REITs have generally underperformed
the wider listed market in 2016.
••All the UK majors are now trading below NAV
although European stocks are faring better.
••2015 proved another strong year for European
private equity real estate with a net increase in
available capital and growing equity queues.
••Investor demand remains solid although
the balance of appetite is shifting from UK
investments to Continental European investments.
••Anecdotal evidence suggests that despite
investors’ declared appetite for higher return
investments, core and core plus products remain
most palatable.
3. Public Debt
4. Private Debt
••CMBS markets suffered in the second half of
2015, spreads rose and new issuance dropped
significantly.
••REIT bond issuance was muted as listed property
companies continued to reduce leverage levels.
••The dislocation between public and private debt
markets provides an opportunity for investors.
••There is greater traction in Europe and lenders
are being more competitive
••Pricing stopped falling and stabilised in the UK
as certain lenders hit their targets by Q4
••Market sentiment is good in Q1 2016
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MACRO SNAPSHOT
•Global market sentiment is now dominated by concerns
over the China, Brazil and Russia slowdown and weak
commodity prices.
•Although Europe economies slowed in the second
half of 2015 (EU GDP growth in H1 was 1% falling
to 0.8% in H2) EU GDP growth for the year as a
whole was 1.8% making it the best year since the
post-crash bounce back in 2010.
•The slowdown was focussed on France and Germany.
There was little evidence of a slowdown in Central
Europe, Spain or the UK (though growth in the UK
for the year as a whole at 2.2% was noticeably down
on the 2.9% recorded in 2014).
“Economic forecasters are
still pointing to growth in
2016 which is similar to
or even marginally better
to 2015 driven once again
by consumer spending”
•The pick-up in growth for 2015 as whole was very
consumer dependent with consumer spending benefiting
from the boost to real incomes from lower commodity
prices and the confidence enhancing impact of ongoing
falls in unemployment.
•Economic forecasters are still pointing to growth in
2016 which is similar to or even marginally better
to 2015 driven once again by consumer spending.
•Euro area CPI inflation has picked up from negative
values but is still well short of targets.
•Expectations that the ECB’s QE policies will be
extended further in response to persistent low inflation,
a weakening international environment and equity
market volatility.
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DIRECT PROPERTY
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The key takeaway about Q4 2015 in the direct commercial
real estate market was a divergence between the UK and
the rest of Europe in terms of market turnover. Whereas
the UK recorded a lower level of investment activity than in
Q4 2014, turnover in the rest of Europe continued to grow
strongly, reaching a record quarterly total.
The UK and the rest of Europe are also diverging in terms
of pricing. Prime yields in the UK have been generally
stable for the last six months, except for the very best
city centre retail assets which remain hotly contested. In
contrast, prime yields in most major European markets
continued to sharpen in the second half of 2015. Prime
office yields compressed to 3.25% in Paris, 3.65% in
Munich and 4% in Milan and Stockholm, for example.
Continued investor demand suggests that this isn’t a
harbinger of a sharp decline in the UK market. Rather,
investors in the UK appear to be increasingly selective
when evaluating acquisitions. The market has ‘taken a
breather’ and buyer urgency to complete transactions
– a clear feature at the end of both 2013 and 2014 –
is no longer as evident.
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The differing monetary policy stances of the Bank of
England (BoE) and the European Central Bank (ECB) may
also offer a partial explanation for this divergence. The
UK economy’s relatively strong performance during 2015
led analysts to speculate that the BoE would follow the US
Federal Reserve in raising official interest rates in the first
half of 2016. Prospects of tighter monetary conditions in
the UK contrasted with the expectation that the ECB would
continue its programme of Quantitative Easing into 2017
in response to the sporadic economic growth in Europe.
Put simply, for property investors the Eurozone seemed to
present a better ‘lower for longer’ bet than the UK.
For occupiers, the low level of development activity of
recent years is starting to bite. In the continental European
locations with the best growth, occupiers are confronted
with a paucity of good quality, well located space and little
supply in the pipeline. The UK is further down the same
road. Stronger economic growth and limited new supply
is starting to drive rental growth in many markets and
developers are also responding, particularly in London.
2016 in Focus
CRE Investment in Europe
90
80
200
Rest of Europe 12 Month Rolling Total (RH)
180
140
60
120
100
40
80
30
60
Q4 2015
Q2 2015
Q4 2014
Q2 2014
Q4 2013
Q2 2013
Q4 2012
Q2 2012
Q4 2011
Q2 2011
0
Q4 2010
0
Q2 2010
20
Q4 2009
10
Q2 2009
40
Q4 2008
20
Q2 2008
Billion €
50
Q4 2007
With yields often already at record lows, income growth will be the key to performance. That will be driven
by rental growth in prime markets, or higher occupancy/more secure income for more secondary property.
Current vacancy, development pipeline and demand vary considerably both between cities and within cities,
so outperformance will be more local than was the case when yield shift was the main performance driver.
UK 12 Month Rolling Total (RH)
160
Q2 2007
What is the main driver of outperformance?
Rest of Europe (LH)
70
What should investors watch for in terms of downside risk?
The turmoil in equity markets since the start of the year is symptomatic of investors’ nervousness about
contagion from economic weakness in emerging markets – China, South America, Russia. Investors
should be watching to see whether stock market volatility becomes a sustained slump as this would herald
economic effects that would have knock-on effects in the real estate sector.
UK (LH)
Source: CBRE.
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Billion €
With economic growth in the euro area now in what looks like a more sustained recovery, 2016 could be
the time for some of the less favoured markets of recent years to catch up with what has already been seen
elsewhere. The yield differential between CEE cities and second and third tier cities in Western Europe,
particularly France and Italy, is starting to look attractive.
Q4 2006
What are the investment trends to look at this year?
PUBLIC EQUITY
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The final quarter of 2015 saw listed equity markets
continue the year’s volatile track, rallying strongly
during October before materially rerating during
the rest of the fourth quarter. The EPRA index was
up 2% in Q4, with the UK down 2% (in euros), and
Continental Europe up 5%. Over 2015, both Continental
Europe and the UK delivered a price return of 15%
in euros. In local currency the UK returned 9%.
This reflected the year’s themes including euro QE, the
return of modest economic growth in the Eurozone and
an easing of UK growth. Strong performers included
the previously less favoured periphery of the Eurozone,
with Spain and Ireland showing strongly, conversely
France and the Benelux lagged. In the UK, the small
caps provided some star performers and London
focused companies outperformed the retail specialists.
2016 in Focus
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The UK majors have all stepped back to significant
discounts with even highly regarded London
specialists now below NAV. European companies
are more widely spread with, for example Unibail
still at a material premium. The UK is now at a
materially wider discount than the Continent.
The rise in listed markets triggered by euro QE has
been given back with prices below the preceding trend.
Commentary is focused now on what might go wrong,
and whether share price movements are a forward
indicator for physical assets. However, current price
levels provide a degree of comfort. In the UK in particular,
it would require a marked weakening in investment or
occupation market conditions to mount a sustained
challenge to property stocks on the downside.
Since the New Year, markets have continued to
fall amid global instability. The UK is down 12%
to pre Euro QE rally levels. Continental markets
have been stronger but are still off 4%.
What are the investment trends to look at this year?
300
280
What should investors watch for in terms of downside risk?
260
The biggest areas of concern are:
220
•The economic performance of emerging markets.
•Geopolitical instability focused on the Middle East.
•The trajectory and impact of tightening by the Fed.
•Whether or not there will be a Brexit.
200
160
140
120
Dec 2015
Sep 2015
Jun 2015
Mar 2015
Dec 2014
Sep 2014
Jun 2014
Mar 2014
Dec 2013
Sep 2013
Jun 2013
Mar 2013
Dec 2012
Sep 2012
Jun 2012
Mar 2012
Dec 2011
Sep 2011
Jun 2011
Mar 2011
Dec 2010
Sep 2010
Jun 2010
Mar 2010
100
Dec 2009
There is upside if returning economic growth continues in the UK and across Continental Europe, supported
by the impact of low commodity and especially oil prices and the low interest rate environment. What
appears to be a rather bearish rerating could ease in the absence of either strongly rising rates, a demand
shock or a drop-off in economic growth.
180
Mar 2009
What is the main driver of outperformance?
240
Sep 2009
On the Continent, both real estate and, despite recent falls, listed equity prices have reacted positively to
easing Eurozone concerns and strengthening GDP growth; increasing the focus on delivery in occupational
markets.
EPRA Index
Jun 2009
The UK market is trading at a material discount to the physical asset markets, especially the majors with their
high quality, diverse portfolios, robust balance sheets and progressive dividends.
Source: Bloomberg.
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PRIVATE EQUITY
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In the customary end-of-year assessment of the year
passed, private equity real estate investors might have
been reasonably satisfied with their exertions in 2015.
According to Preqin, managers raised US$100 billion
of equity during the year bringing the total amount of
uncalled capital to US$220 billion. After allowing for
the US$189 billion returned to investors, the net increase
in new capital at the disposal of private equity managers
was approximately US$31 billion.
Of this US$220 billion of uncalled capital, Preqin
estimates that around 30% (US$66 billion) is earmarked
for European assets. This equates to approximately 28%
of European investment transaction volume in 2015
(US$264 nillion) and is consistent with the investment
themes evident in the direct and listed markets.
2016 in Focus
What are the investment trends to look at this year?
A slowdown in the rate of appreciation will put increasing emphasis on income and income growth in core
funds. In opportunistic funds there may be greater emphasis on the velocity of return.
These statistics point to continued investor support for
private equity real estate investment generally and for
European assets in particular. At a more granular level,
we see a possible disconnect between the level of risk
investors state they are seeking and the investments being
made. The INREV investment intentions survey, published
in January 2016, records a clear investor preference
for value-add strategies; seeking to secure income
by backing managers that actively generate higher
returns rather than rely on price appreciation. However,
anecdotal evidence and the lengthening investment
queues in European core funds suggest investors are
increasingly being drawn to the potentially lower but more
secure income of core and core-plus strategies.
The secondary private funds market continues to grow
at pace. Trading volumes at our secondary trading desk,
PropertyMatch, grew approximately 30% year-on-year
driven by substantial increases in Continental Europe
and US trades. Trading in the UK remained broadly flat
on the previous year.
With the first two months of 2016 almost finished,
our expectation of more-of-the-same for this year
appears sound.
Demand for euro denominated funds is likely to remain
high throughout 2016 with secondary trades exchanging
hands at premiums to NAV in highly sought after funds.
The UK seems further advanced in the economic cycle
and the inflow of capital does appear to slowing, but
we do not expect a significant reversal in capital flows.
A possible wobble for the private equity real estate
investor may arise if the current bear market in equities is
prolonged and REIT discounts to NAV remain where they
are. If this happens, it will be interesting to see if investors
re-weight from unlisted funds to REITs in search of a
lower pricing threshold or whether the same trend attracts
investors to the perceived lower volatility of unlisted funds.
What should investors watch for in terms of downside risk?
In UK open-ended funds the redemption queue will increasingly come into focus
in a slower growth environment. In recent years sellers have been able to trade in the secondary market
at premiums to bid, but if secondary market pricing falls, we may see increasing requirements for primary
liquidity.
What is the main driver of outperformance?
The appreciation game is largely played out. Repositioning assets so that they are best positioned
to benefit from increased economic activity is likely to generate superior returns.
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PUBLIC DEBT
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13
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The volatility in equity and commodity markets and the
nervous environment of late 2015 contributed to muted
public real estate debt markets.
Corporate bond issuance by REITs was minimal. But
although activity was limited, it was noteworthy that
borrowing spreads held firm suggesting investors were
watching rather than worrying. REIT gearing levels remain
low – most of the major REITs are maintaining gearing
at record lows – despite the very large spread between
property yields and corporate debt rates. This conservative
financial risk management perhaps reflects management
and investors’ memories of the problems of high leverage
during the global financial crisis.
Dislocation between syndicated and securitised markets may provide an opportunity for issuers who can
source the right product.
45
40
Nov 2015
Mar 2015
Jul 2014
Nov 2013
Mar 2013
Jul 2012
Nov 2011
Mar 2011
Jul 2010
25
Nov 2009
The ‘relative value’ play. Look at AAA CMBS spreads of around 135 basis points (source BoAML)
versus other markets.
Mar 2009
30
Mar 2005
What is the main driver of outperformance?
Jul 2008
35
Nov 2007
More hawkish monetary policy in the US and eventually the UK could also negatively impact real estate
credit, though this seems some way off for now.
Total Debt to Assets Ration (%)
50
Mar 2007
Wider credit markets are vulnerable to weakening global growth prospects and any knock on impact of
investors selling in the sub-investment grade market.
55
Total Debt to Total Assets
What should investors watch for in terms of downside risk?
A repeated theme in previous Four Quadrants is that
a return of the CMBS market to historic, large scale
issuances levels looks unlikely until we see penal
regulatory capital treatment of securitised assets ease,
particularly for the insurance industry. We continue to
hold this view. However, the sound fundamentals of
the direct real estate market and the yield that may be
available remains attractive to investors in a low inflation
environment. In the quest for product, the lure of a liquid
yield investment may motivate investors to adjust their
portfolios to manage the regulatory capital challenges in
order to allow them to hold more CMBS and other forms
of ‘bond format’ real estate debt.
UK REITS: Total Debt to Assets Ratio
Jul 2006
What are the investment trends to look at this year?
Nov 2005
2016 in Focus
Conditions in the high yield debt markets had knock on
effects for the CMBS market where widening spreads
resulted in a number of planned issues being shelved.
Potential issuers were forced to change or delay plans
as the deterioration in margins impacted on some deals’
already tight profit margins. Markit reported that spreads
on BBB rated CMBS increased by over 100 bps over
the last six months. Despite these widening spreads, we
expect to see an increase in CMBS activity in the first half
of 2016 with new issues securitising alternative and nonmainstream property loans.
The quiet conditions of the securitised real estate loan
market contrasts with the relatively busy market for
syndicated real estate loans. Such disparities are unusual
and we would expect the level of activity in the markets
to converge. This convergence may present an arbitrage
opportunity for potential lenders with the right product to
achieve competitive funding in the CMBS market.
Source: Bloomberg, BAML
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PRIVATE DEBT
14
15
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Over the last few years, new entrants have revitalised the
real estate private debt market and increased dynamism
and competition. Reflecting this, 2015 was probably the
busiest year for CRE lending of recent times since the
recession. In this environment, certain borrowers have
had their pick of lenders for desirable deals.
In the final quarter of 2015, there was a slight but
discernible moderation. Some lenders did not compete
as strongly for deals and would not move on pricing
as easily as they might have done 12 months prior.
This moderation was partly due to these players having
filled their allocated targets for 2015 and focusing on
developing pipeline for 2016. However, some lenders
may also have been unable to reach minimum required
return thresholds in underwriting, reflecting the competitive
investment market conditions – particularly in London.
A further development was the appetite of debt providers
to follow equity investors into Europe by lending on
European assets and portfolios. With the European real
estate cycle being slightly behind the UK, lenders see
an opportunity stemming from more attractive margins
available on strong underlying European real estate.
LTV ranges remain stable and the quantum of debt banks
will hold did not change significantly in Q4 2015. For
larger European deals, local lenders often only have
capacity to lend up to around €50 million and so need to
participate with other parties. This leaves an opportunity
for global lenders and the larger debt funds which can
often write whole loans, albeit the pricing may be less
competitive for borrowers.
The development lending market reflects the broader
theme of the UK being further advanced in the economic
cycle than continental Europe. Traditional development
lenders in Europe – particularly the major banks –
have been reluctant to lend, creating an opportunity
for funds and bridging finance providers. While
European development activity has been limited, where
opportunities do exist, these generally higher cost lenders
are taking advantage of the lack of competition to earn
fatter lending margins by financing borrowers looking to
take development and/or planning risk.
Overall, in early 2016 lender sentiment is broadly positive
with many providers both widening their lending scope
and seeking to fill large targets.
2016 in Focus
What are the investment trends to look at this year?
Lenders are seeking opportunities to expand in Europe as competitive pressure in the UK combines with
positive lender sentiment.
In a competitive market, borrowers will be well served by focusing their effort on working with lenders that
suit the real estate asset class they are looking at.
What should investors watch for in terms of downside risk?
Tight or unrealistic covenants, should there be a change in market dynamics.
What is the main driver of outperformance?
Market dynamics and new entrants in the market.
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CONTACTS
For more information regarding this report please contact:
Anthony Martin
Executive Director
Investment Advisory
t: +44 20 7182 2466
e: anthony.martin@cbre.com
Paul Robinson
Executive Director
Alternative Investment
t: +44 20 7182 2740
e: paul.robinson@cbre.com
Michael Haddock
Senior Director
Research
t: +44 20 7182 3274
e: michael.haddock@cbre.com
Paul Lewis
Senior Director
Loan Advisory
t: +44 20 7182 2871
e: paul.lewis@cbre.com
Graham Barnes
Executive Director
Corporate Finance
t: +44 20 7182 2516
e: graham.barnes@cbre.com
Nuala Conneely
Associate Director
Debt and Structured Finance
t: +44 20 7182 2979
e: nuala.conneely@cbre.com
This report was prepared by CBRE Capital Advisors and the CBRE EMEA Research Team.
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