The northern English city of Manchester is best known for its powerhouse football teams and vibrant music scene. Lately, however, the city’s property market has been turning heads.
In February 2013 the asset and wealth management division of Deutsche Bank led a £142 million ($221 million) deal to buy One Angel Square, a gleaming new glass-walled office block in the city’s commercial center that’s one of the most modern and energy-efficient buildings in Europe. The transaction was notable for its junior partner: the State Administration of Foreign Exchange, the arm of the Chinese central bank that manages the country’s vast currency reserves. SAFE’s participation in the transaction marked its first European property purchase outside London. In addition, the acquisition was priced to give an initial investment yield of less than 6 percent, a new low for deals outside the British capital.
SAFE is not alone. Over the past year sovereign funds have been snapping up prime properties in London and have begun to make inroads into Europe — a wave of activity that’s accelerating. In December, Singaporean sovereign wealth fund GIC purchased a 50 percent stake in Broadgate, a sprawling office complex on the edge of the City of London financial district, for £1.7 billion, in one of 2013’s biggest deals. And in January of this year, China Investment Corp., a $650 billion sovereign wealth fund, shelled out £800 million for Chiswick Park, a 33-acre (13-hectare) office park in West London.
“To be seen as a credible international investor, you need to own something in London,” says Mat Oakley, head of European commercial property research at Savills, a London-based real estate services company.
The sovereigns’ buying power has helped push real estate prices in prime areas back to precrisis levels, with yields on recent deals in London and some prime German markets well below 5 percent. Chinese insurance companies and property developers are also starting to enter the market, adding to the competition for prime properties. The influx of money is having ripple effects on smaller markets across Europe as the region’s traditional investors — real estate funds, insurance companies and pension funds — search further afield for value.
“Currently, the competition for core product is very high, and there is still pressure on yields,” says Marcus Lemli, head of investment in Europe and CEO for Germany at Savills. “But I expect the overall gap between prime and secondary yields to close further, with investors spreading out across the risk-return spectrum.”
European commercial property transactions rose 21 percent last year, to €154 billion ($212.1 billion), according to figures from Los Angeles–based real estate firm CBRE Group. Europe is the only region in the world to see a net increase in capital inflows to its property market — more than $20 billion last year, according to Chicago-based property advisory firm Jones Lang LaSalle. Most analysts expect the inflows to intensify.
In some cases the impact of sovereign funds on longtime investors has been direct. In January, Deutsche’s asset and wealth management division, acting on behalf of Malaysia’s largest pension fund, Employees Provident Fund, bought three shopping centers from the investment arm of U.K. insurer Aviva for £156.5 million.
Under the deal the Kuala Lumpur–based fund, which invests for more than 6.5 million workers, acquired a 50 percent stake in the centers while Tesco, a Hertfordshire, U.K.–based supermarket operator whose stores anchor the centers, took the other half. The deal produced a yield, measured by current rental income as a percentage of the sale price, of less than 6 percent. If the stores had been in the greater London area, no one would have batted an eye. But these properties are located in places where foreign investors rarely tread: the windswept British seaside resorts of Thanet and Blackpool and the Midlands city of Coventry.
“There has been a very significant change in sentiment to real estate, with investors generally willing to accept more risk,” says David Skinner, chief investment officer for real estate at Aviva Investors Global Services, the London-based insurer’s asset management arm. “A couple of years ago, they were very focused on the security of the income stream, the primeness of the location, the building specification, the quality of the tenants, the lease length and so on. Now there is much more willingness to compromise on one or more of those criteria.”
In the Manchester deal Gingko Tree Investment, SAFE’s real estate unit, took a 49 percent stake in the property, according to sources familiar with the purchase. (The building serves as the headquarters of the Co-operative Group, the U.K.’s largest member-owned company.) The remainder was bought by Grundbesitz Europa, a real estate mutual fund managed by DWS, Deutsche’s German fund management arm. Grundbesitz Europa, which had assets of €3.99 billion at the end of March, is a conservative investor that seeks to produce steady income from a portfolio that includes buildings on the Champs Élysées in Paris and in downtown Frankfurt. The fund generated a return of 2.7 percent in the 12 months through March, ranking it 18th out of 77 comparable funds, according to data and publishing group Citywire.
Officials at Gingko and SAFE did not respond to requests for comment, but industry sources say the Chinese fund has been one of the most active property investors in the U.K. over the past two years. In August 2012, Deutsche helped Gingko buy Drapers Gardens, a 16-story office building in the City of London that serves as the European headquarters of U.S. asset manager BlackRock. The property sold for £285 million, generating a yield of 4.5 percent.
Although investors are expanding their horizons well beyond central London, the British capital continues to be a hotbed of activity. U.K. real estate transactions surged by 33.5 percent in 2013, to €55.7 billion, driven largely by global money flocking to London, according to CBRE. Yields, or current rental income as a percentage of the property’s sale price, routinely fell below 5 percent in London’s financial district and below 4 percent in the West End, home to hedge fund firms and the city’s prime retailing territory.
“London benefits from its status,” says Simon Durkin, head of property research and strategy for Europe at Deutsche Bank. “Admittedly, it led us into global meltdown, and it’s one of the first markets to lead us out. It reacts very quickly.”
Recent buyers include such renowned names as Singapore’s GIC. The sovereign wealth fund purchased the Broadgate stake from New York–based investment firm Blackstone Group, the world’s largest private equity real estate investor, with $79 billion under management. The other half of the property is owned by British Land Co., a London-based real estate investment trust. The 17-building complex abuts the Liverpool Street railway station and is home to Zurich-based UBS, which will shift its investment banking offices to a new, custom-built structure on the site.
Blackstone had invested in Broadgate in 2009, when British Land, then the sole owner, needed cash to reduce its debt. In that deal, which valued the property at a little more than £1 billion, Blackstone injected just £77 million of equity and agreed to shoulder half the estate’s £1.97 billion of borrowings. With the recent sale Blackstone made a return of more than four times its original investment in barely four years.
“It was a rare opportunity to acquire a world-class office complex of such a scale, and Broadgate matches our desire to invest in assets where we can add value,” says Christopher Morrish, head of Europe for GIC Real Estate. London may have been hard-hit by the financial crisis, but it will continue to be a major financial hub and an attractive target for GIC, he explains. Broadgate offers both secure income streams from existing tenants and the opportunity to “reposition and maybe redevelop the buildings over time,” Morrish adds.
Other large sovereign investors, including Norway’s Government Pension Fund Global, had looked at the property. Last year GPFG, the world’s largest sovereign wealth fund, decided to increase its allocation to real estate to 5 percent of its $859 billion portfolio. Although GPFG has broadened its horizons to the global level, it has continued to plow considerable funds into the U.K. and European markets. In December it invested £97.5 million in a 25 percent share of a new building on London’s Regent Street as part of a joint venture with the Crown Estate, which manages the property owned by Queen Elizabeth II. A year before, GPFG set up a €2.4 billion joint venture with San Francisco–based Prologis, a multinational logistics company, to invest in warehouses across Europe.
SAFE, meanwhile, isn’t the only Chinese buyer in the market. In July 2013, Shenzhen-based Ping An Insurance (Group) Co. of China, the country’s largest private insurer, paid £260 million for the Lloyd’s of London building. The purchase of the Richard Rogers–designed structure, distinctive for its vast atrium and exterior ducts and elevators, was the first property investment by any Chinese insurance group outside the mainland. It followed a relaxation of investment rules by both China and Taiwan that opened the door for their insurers to buy real estate outside their home markets.
Given Asian insurers’ appetite for property, analysts believe Ping An will soon have company. Real estate firm Savills predicts that Asian insurers could invest £10 billion in European property, predominantly in London, in coming years. Savills estimates that there are more than 20 insurers in China and Taiwan with the desire and firepower to do deals.
“The investment wave by insurance companies is just starting,” says Paul Boursican, head of international investment for Europe, the Middle East and Africa at Chicago-based property advisory firm DTZ, whose team visits Chinese and Asian investment groups every two months. “This wave will be mature in the next 12 to 24 months. Ping An was the first, but others are ready to buy.”
Several Chinese entities dipped a toe into the U.K. market in the past year. In January, Greenland Group, a Shanghai-based developer, bought a dormant brewery in the southwest London borough of Wands-worth for about £600 million. It plans to build housing, offices and retail stores on the site. Greenland followed in the footsteps of China’s largest property group, Dalian Wanda Group Co., a $48 billion, Beijing-based outfit led by China’s wealthiest man, Wang Jianlin. That company bought a development site at Vauxhall, just south of the River Thames, in June 2013. It plans a £700 million development that will include a five-star Wanda hotel, London’s first Chinese luxury hotel.
The spate of investment follows a concerted effort by senior British politicians to woo Chinese investors. On a trade mission last year, London Mayor Boris Johnson met with Dalian Wanda’s Wang to promote his city as an investment destination. Wang has pledged to invest as much as £3 billion in regeneration and infrastructure projects in the U.K. over the next few years.
The Chinese appetite for European investments seems voracious. “There’s more money around today even than there was in 2006–’07,” said Philip La Pierre, head of real estate investment management in Europe for German mutual fund manager Union Investment, at a recent investment roundtable. “The question is, what are you going to do with it? Everyone has money; what they don’t have is stock.”
Faced with a huge wave of competing capital from Asia, some domestic buyers are being forced out of markets where they have long been active players. Institutions like Aviva Investors find it difficult to compete for assets in central London, particularly when they are bidding against Asian pension funds that are looking for diversity and see good value even in the pricey end of the European market. Yields on office property in Seoul, South Korea, for instance, can be as low as 2 to 2.5 percent, analysts say. In addition, whereas European commercial investors are desperate to generate yield in today’s low-interest-rate environment, many big Asian sovereign wealth funds have no specific long-term liabilities to match.
“We have now got to the point where such has been the repricing in the prime end of the central London office market that it doesn’t look like good value to us,” says Aviva’s Skinner. “We as a business and many of our clients will be seeking to hold an underweight position in central London offices on the basis of poor relative value.”
Aviva and its peers — such as Edinburgh, Scotland’s Standard Life and London-based asset manager Henderson Global Investors, which is in the process of merging its property operations with those of U.S. retirement fund manager TIAA-CREF — have been advocating a move into smaller cities or older properties in need of refurbishment, new tenants or better management. That puts them into competition with a different kind of investor, however.
London-based InfraRed Capital Partners, the former infrastructure and real estate arm of British bank HSBC Holdings, has seen several conservative European property investors move into its territory after being squeezed out of prime markets by foreign money.
“What we sense is indirect competition,” says Andreas Katsaros, the InfraRed director responsible for deal origination. “We are not really competing with Asian capital, but what we do see is Asian capital coming in for the very large and very prime assets. That capital is coming at a very different risk premium, so that pushes local institutions out further afield.”
In late 2011, InfraRed bought the Cologne Tower, a 43-story office building in the German city, for about €100 million and embarked on a €15 million refurbishment of its façade, lobby and elevators in a bid to boost the building’s low occupancy rate and increase rental values. The firm estimates the property is now worth about €150 million. Ultimately, it aims to sell the tower to a sovereign wealth fund or big Asian investor looking to diversify into the Continent.
Deal volume in Germany rose 20 percent last year, to €30.4 billion, making it Europe’s second-busiest real estate market, according to CBRE. International investors tend to focus on financial center Frankfurt or the Bavarian city of Munich rather than national capital Berlin. Large domestic players aren’t exactly ceding the territory, though. In October 2013 the pension fund for German auditors and accountants, WPV, and PPG Holdings, the pension fund for PricewaterhouseCoopers’ German partners, secured Germany’s largest office deal. They paid €330 million to buy a two-thirds stake in the country’s fourth-tallest skyscraper, Tower 185 in Frankfurt, from Austrian real estate group CA Immo.
Strong demand from both domestic and international investors “is driving initial yields down and prices further up,” says Savills’ Lemli. He expects even greater interest in Germany from Asian investors next year and an increase in transactions.
According to Savills’ research, some German cities boast among the lowest yields in Europe. They stand at 4.25 percent in Munich, 4.4 percent in Frankfurt and 4.5 percent in Hamburg.
International investors aren’t stopping in Germany. They are moving into some of Europe’s hardest-hit economies in a search for attractive yields.
Consider Ireland, where a postcrisis property bust bankrupted the banking system and forced the country to seek a bailout from the European Union and International Monetary Fund. Irish property transactions surged by 228 percent last year, to €1.8 billion, according to CBRE. In Italy, struggling to escape from a long recession, deal volume jumped by 73 percent, to €4.4 billion.
International buyers have collided with domestic investors in those markets, pushing prices beyond expectations on some notable deals. The recent sale of an unfinished multiuse project with offices, apartments, retail and leisure in Dublin’s plush Leopardstown suburb attracted a host of bidders. The development was won by a consortium made up of Ireland’s first real estate investment trust, Dublin-based Green REIT; Beverly Hills, California, investment firm Kennedy Wilson; and Newport Beach, California–based Pacific Investment Management Co. They paid €61.5 million over the €250 million asking price set by the National Asset Management Agency, an entity created by the Irish government to work off a mountain of bad debts.
Investors are also shifting their attention to Spain, home to an even bigger property bust than Ireland’s. In late March, Ignacio González, president of the Madrid regional government, told reporters that Spain’s Banco Santander had agreed to sell the Edificio España, a 25-story, Franco-era building in the heart of the capital, to Dalian Wanda for €260 million. Santander did not confirm the sale, and local media have reported that the Chinese could still face rival bidders, but even if the Chinese lose this property, experts say it’s only a matter of time before they make their mark.
“Next week I will have some Chinese investors in London, and they want to focus on Spain,” says DTZ’s Boursican. For large developers such as Dalian Wanda and Greenland, Spain offers an opportunity to absorb some of the glut of luxury apartments and resell them to private Chinese buyers. The lure? The Spanish government offers residency for foreign investors who spend more than €500,000 on real estate.
Boursican estimates that there are at least 15 Chinese investment and development companies that could each plow $1 billion or more into European deals. “These guys have massive money, they take risk, they are coming into the market, and they want to do more,” he says.
Such deals may be far removed from the stable, income-producing prime properties being sought by pension funds and sovereign wealth funds, but they indicate just how far the ripples have spread since Gingko’s plunge into Manchester last year. With the influx of money inflating prime and secondary markets alike, some industry experts believe some of the recent arrivals may begin to turn to real estate investment funds — vehicles that many of them used to get their first taste of property investing. Such funds can give big investors access to smaller deals than they would be willing to do by themselves and to properties that need the kind of hands-on management that they cannot provide.
“Asian investors are being pushed into taking higher risks, and they are now considering coming into funds such as ours because they can’t deploy enough capital,” says InfraRed’s Katsaros. “They don’t necessarily want to invest in funds, but they realize that if they want to diversify and get exposure to the European property market, it is very difficult to do that just through core and club deals.”
The race to deploy capital inevitably brings the risk of overpriced deals, both on the European periphery and in London. Savills expects prime office property yields in Madrid will fall to 5 percent this year, after hitting 5.5 percent in the first quarter. The volume of transactions quadrupled in the first quarter from a year earlier, to €200 million. It’s a small amount in the context of the overall European market, but it provides a clear indication that sentiment is changing quickly in Spain, notwithstanding the country’s unemployment rate of more than 26 percent. “When you see that competition, there is always the risk of pricing getting ahead of itself,” said Deutsche Bank’s Durkin.
In London analysts at Deutsche Bank and Aviva are already factoring falling prices and diminishing returns into their five-year plans. Rising bond yields as central banks begin to withdraw monetary accommodation are eventually likely to diminish the attraction of real estate and affect prices, they say. The rental market, currently buoyed by a lack of new space for businesses that are feeling more bullish about the economic outlook, should begin to turn soft in about three years as the supply of new buildings comes onstream, they add.
It’s the familiar story of boom and bust in the property market. Five years ago it left banks holding billions of euros of bad loans for overleveraged offices, retail parks and land for development. This time, however, the outlook doesn’t have to be so gloomy. And part of that comes down to the sovereigns’ deep pockets. All-equity deals, or just moderate leverage from lenders chastened by their profligacy in the boom, mean the banks will not necessarily have to take the keys when the values of the prized properties in London, Munich or Madrid fall. Part also comes down to the longer-term outlook of the sovereigns and the pension funds, and the deals they have put in place in the tougher times. When capital values drop, they can wait for the next cyclical upswing to sell or hold on to assets like One Angel Square and enjoy the benefits of inflation-linked rental growth. • •
