jp morgan research report - opportunity seized opportunity missed

7/28/2019 JP Morgan Research Report - Opportunity Seized Opportunity Missed

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1 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe

Opportunity seized,

opportunity missedThe case or opportunistic real estateinvestment in Europe

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2 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe2 | Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe

Executive summary The process o deleveraging as well as badly needed economic and political reorm in

Europe will be long, protracted and painul. Turmoil and uncertainty will persist or some

time yet but it will also provide the basis o opportunity or experienced investors.

The real estate market is quickly moving in avour o the opportunistic investor. However,

this phase o opportunistic investment will likely be dramatically dierent rom that o

previous episodes. No longer will the manager be able to rely almost solely on debt uelled

returns. The backcloth o little or no growth places the emphasis squarely on the ability

o the manager to drive investment returns orward.

Managers with the track record, breadth o nancial and operating experience, as well as

the credibility with which to mitigate execution risk, are increasingly scarce and will carry

a premium in this environment.

Unlike previous phases o opportunistic investing, no investor will likely be rewarded or

taking macro positions on Europe. The winning strategy may have to be underpinned by

a recognition o the value derived rom the current state o extreme risk aversion, the

recapitalisation o deunct capital structures, the active management o assets which have

been in suspended animation or the last 45 years and, above all, a recognition that the

diversity o the European real estate market is both mispriced and undervalued.


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Opportunity seized, opportunity missed The case or opportunistic real estate investment in Europe | 5

Exhibit 1 | Its opportunistic investing, but not as you know it!

Source: J.P. Asset Management

Keythemes

Early2000s

Today Implications for theinvestment manager (IM)

Macropositions

The European market was bothopaque and inecient. It was alsothe subject of frantic de-regulationand increasing EU accession. Thisallowed for significant re-pricing ofmarkets allowing macro positionsto be taken (CEE or Germanresidential).

Improvements in transparencyand liquidity transformed themarket in terms of pricingeciency. At the same time theincreased polarisation inperformance precludes the takingof macro positions on particularsectors or specific regions.

Opportunistic returns in the early2000s were both reliant andfuelled greatly by the availabilityand cost of debt. Investmentstrategies could be very simple acquire property, ensure it washighly geared and wait for yieldsto compress.

The pool of commercial realestate (CRE) debt is and will bemuch reduced. Managers willalso need to contend withsubstantially lower loan to values(LTVs) and higher margins.

The IM with a good trackrecord and goodrelationships with themajor lenders will be ableto take advantage ofstapled debt in theopportunistic segment ofthe market.

At the time Europe was enjoying aperiod of unprecedented growth,in the midst of a long bull-runwhere property investment cameto be seen as risk free.

Economic recovery will be slow andpainful with little or no growth inthe medium term. This means thatone of the most important driversof opportunistic returns will be lesssignificant.

The IM has to relyincreasingly on hands-on,operational expertise.

Investment returns were drivenprimarily by debt and relatively highrates of economic growth.

Investment returns will be moremodest and, as important, the keydriver of value growth has shiftedmost decisively to the ability of themanagement team.

IM with the financial andoperating experience willhave a distinct competitiveadvantage in counteractingthe eects of lower growthand less debt.

The IM has to have directaccess to local marketsand network of partners.

Financing

Growth

Investmentreturns

Definitionof core

Investmentuniverse

Execution risk

Investmentmanagementindustry

Leasingmarkets

Developmentactivity

Development activity was at a highpoint providing a steady supply ofcore assets to the institutionalmarket. At the same time demandfor such assets was restrictedprimarily to domestic institutionalsources.

Extreme risk aversion has led to aredefinition of core. Core assetshave to have a tick in all the rightboxes meaning that even thoseassets with minor impairments, andotherwise regarded as institutionalin a more normal market are beingpriced as secondary.

IM will be able to takeadvantage of assets withminor impairments andotherwise regarded asinstitutional throughinjection of capital andactive management

During the early 2000s, investorshad to go to Tier II and III marketsand the smaller and less liquidcentral and eastern European (CEE)markets to generate the sort ofopportunistic returns required.

The opportunistic investor is beingrewarded for taking risk even in thelarger and most transparentmarkets in Europe. Extreme riskaversion has meant that reasonablereturns can be generated in majorcentres throughout Europe.

Local knowledge andexperience in core marketswill be crucial for the IM

The weight of capital and, inparticular, the ready availability ofdebt, greatly reduced the level ofexecution risk in the market.

The process of de-leveraging andgeneral risk aversion has increasedoverall risk of successful executionof transactions.

The credibility of the IM willbe critical in convincingcounter parties of the abilityto successfully completecomplex transactions

Characterised by a wave of newmanagers with little or no trackrecord or experience of depressedmarkets.

The investment management industryhas consolidated as evidenced bythe number of funds looking to raisecapital. Regulatory change (AlternativeInvestment Fund Managers Directive)will speed up this process.

IM with deep financial andoperating experience ofdepressed markets are atpremium

Real estate cycle was characterisedby a synchronised recovery andgrowth phase across the Europeanmarket which, over a period, spilledover to Tier II markets as well asthe periphery.

The downturn was notsynchronised whilst performancehas subsequently been highlypolarised. This divergence isevident in both the leasing andcapital markets.

The bifurcation of marketsprovides opportunity forthe IM at both ends of thespectrum. To take leasingrisk in those markets whichcontinue to experience lowvacancy and developmentactivity and seek changesof use in markets withstructural levels of vacancy.

Development activity in the early2000s was at peak levels with thehighest construction boom in mostof the major European markets.

Development activity has been lowin most locations throughoutEurope during this cycle. This hasled to a shortage of grade A stockfor occupiers as well as anincreasing shortage of investment

stock for institutions.

The IM with refurbishmentand developmentexperience will be able tofeed the institutionalappetite for coreinvestment assets which the

market has failed to deliver.


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Dierent drivers o investment returns

As the market continues to move sideways, with little evidence o a robust or sustainable recovery

in values, the driver o value growth has shited rom debt to the asset managers ability to create

value. The increasing shortage o debt in commercial real estate (CRE) and the prospect o little to

no macro growth in the short term will inevitably lead to more modest returns at the opportunistic

end o the market. However, o equal importance is the act that the real driver o value creation

has shited to the asset management team, their track record, operational experience and credibility

in mitigating execution risk.

Exhibit 2 | Drivers o capital value change

60

70

80

90

100

110

120

130

140

150

160

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Cap ta va ue n ex

Finan

ciale

xperien

ce

Operational experience

Source: J.P. Morgan Asset Management, IPD

Exhibit 3 | Contributors to investment returns

Source: J.P. Morgan Asset Management

Financial leverage

Market

Asset management

Financial leverage

Asset management

Market

Pre-crisis Post-crisis


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Capital really does have value

Not only has the majority o investment capital gravitated to the core market, but in so doing, has

redened the very meaning o core. Extreme risk aversion has meant that the investment

universe o core property has shrunk during this cycle. As a result, a large proportion o assets

previously considered institutional but with minor impairments or, slight blemishes, are now

being priced as secondary.

Exhibit 4 | Risk aversion shrinks denition o core today


Moreover, these institutional assets in good locations are being mispriced as secondary despite

having deects which are easily sorted through an injection o capital, or simply by improving its

management.

Exhibit 5 | Secondary pricing at attractive spreads

Source: J.P. Morgan Asset Management, CBRE

Liquid assets

need to be

grade A in every

respect: location,

asset quality,lease length,

covenant.

Extreme risk aversion has

left behind whole swathes

of assets which just fail to

meet the grade even

though impairments can be

rectified with injection of

new capital and active

management.

Core

investment

universe

today

Core investment

universe in

normal market

conditions

Prime

Spread between prime and secondary property in the UK

Secondary

12%

10%

8%

6%

4%

2%

0%

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12


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Furthermore, what is abundantly clear is that yield spreads between prime and secondary markets

are now at a point previously unseen. Going as ar back as the early 1990s, yield spreads narrowed

in the early 1990s, the early 2000s and again in 2006-07. They are correctly at their widest margin

refecting, above all, the extreme risk aversion evident over the last couple o years. It may be

unreasonable to expect these spreads to narrow to the 1% gap seen in 2007-08, but a narrowing

to 1.2%-1.3% would appear reasonable rom their current level o 2%+.

Exhibit 6 | Yield spreads - Prime v Secondary Markets (bps)

1.00

1.20

1.40

1.60

1.80

2.00

2.20

Q2-1991

Q4-1991

Q4-1992

Q4-1993

Q4-1994

Q4-1995

Q4-1996

Q4-1997

Q4-1998

Q4-1999

Q4-2000

Q4-2001

Q3-2002

Q2-2003

Q2-2004

Q2-2005

Q4-2005

Q3-2006

Q1-2007

Q3-2007

Q1-2008

Q3-2008

Q1-2009

Q3-2009

Q1-2010

Q3-2010

Q1-2011

Q3-2011

Q1-2012

Source: DTZ Research, as o June 2012


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Diversity is mispriced and under valued

Given the scale o the economic and political problems around Europe, it is inevitable that the

region is being treated as a single, coherent entity, and priced accordingly. However, the decline

in values was not synchronised and neither has been the long and gradual recovery. The

perormance o both leasing and investment markets has continued to diverge in terms o

perormance and that is likely to exacerbate in the uture. The polarisation o markets creates

ideal conditions or opportunistic investors to thrive in: taking on leasing, reurbishment and

development risk in markets with strong leasing undamentals and a positive outlook, as well

as creating value through re-zoning and changes o use in markets where vacancy has reached

structural levels and a large proportion o vacant oce space is not likely to return to

productive use.

Exhibit 7 | Polarised Markets

0

1

2

3

4

5

6

Supply/demand balance

Amste

rdam

Milan

Madr

id

Brus

sels

Fran

kfurt

Rome

Barc

elona

Duss

eldor

f

Berli

n

Munic

h

Hamb

urg

Lond

on(City

)

Lond

on(WE)

Lyon

Paris

(CBD

)

supplyyears

Market Equilibrium

Source: DTZ Research, as o June 2012


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Development cycle

Real estate development activity around Europe is at a 30 year low. This means that, despite the

economic downturn, there is not only continuing demand or quality space rom occupiers, but

also a relatively low supply o new quality assets or investors as well. The lack o quality stock

available in the investment market has been made all the more severe by the strong infow o

long term institutional and sovereign wealth und capital rom outside the region.(3)

Exhibit 8 | Development is at a 30year low

0

1

2

3

4

5

6

Development completions as a % of total stock

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

30 year average

Source: PMA, as o June 2012

Wheres the product?Much o the attention has inevitably ocussed on the banking sector as a source o investment

grade product and, in particular, the act that we have not yet seen the promised wave o

distressed assets on the market. The banking sector in Europe has announced sales o EUR 200bn

over the past 24 months although only a relatively small proportion o this has actually been

executed. Even so, the level o announced sales account or less than onethird o the toxic

balance sheet in the sector as a whole. Banks will become a major source o investment product

but, or the time being, it is reasonable to assume they will seek to maintain the slow trickle o

assets into the market.

While banks are between a rock and a hard place, successive rounds o liquidity injected over thepast threetoour years have been successul in providing something o a respite. The transer o

assets rom bank balance sheets into the market has been slow and ponderous, and though there

is now evidence that this is picking up, the indications are that banks will seek to hold those assets

that continue to pay a coupon in the hope that time will solve the valuation issue. There is

however another group o assets which have been in suspended animation or the last threeto

ve years, where borrowers have lost all equity and where the banks have been unwilling to inject

the required capital to maintain values. These are the assets in the process o being placed on the

market as the banks have come to recognise that the ailure to invest over the last ew years is

costing them dearly as the deterioration in value is unlikely to recover any time soon.

As pressure continues on the banking sector, so the unding gap is wide and getting wider over

time. Indeed, the unding gap in Europe has now doubled over the past 12 months to an estimatedUSD 200bn as the new wave o banking regulation begins to take hold. The unding gap is unlikely

to be plugged in its entirety by alternative sources o nance such as lie companies and the

sovereign wealth unds.(6) This gap will inevitably lead to urther pressure on pricing or those assets

currently held on bank balance sheets.


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Exhibit 9 | Alternative sources o nance

Alternative sources o nance

USDb

illion

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

Insurance CosSWFPrivate equityOEFsUnlisted fundsCMBS

Banks

Source: Morgan Stanley, as o March 2012

However, distress comes in many dierent guises and banks are certainly not the only source o

distressed investment stock. Many German openended unds are now in liquidation mode and

will need to dispose o EUR 25bn plus in core European markets over the next couple o years

a scale o disposals which will undoubtedly impact on pricing in specic markets.

As a group, real estate investment trusts (REITs) appear to be least distressed but they will also be

net sellers in the short to medium term. The pressure on REITS comes rom trying to reduce

leverage, uel existing development plans in the absence o sucient debt in the market, and the

need to ocus on core competencies. Raising new capital in this environment is both dicult and

dilutive with equity markets remaining volatile and the majority o companies trading at a

signicant discount to net asset value (NAV).

The unlisted und sector will also be major sellers as many o the unlisted unds are coming to

the end o their lives as well as seeking to exit as a result o increased cost overheads ollowing

the recent introduction o new European Union (EU) legislation.

Finally, central and regional governments will denitely make up a large component o distressed

real estate sellers particularly in peripheral European markets. All governments are seeking to

raise new capital and the historic portolios held by the public sector is a potentially important

source o value. A number o signicant portolios have recently been placed on the market and

this trend is one that is likely to continue over the next onetotwo years.


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Case study

Distress comes in many diferent guises

Continuous waves o liquidity rom governments and central banks have enabled European

banks to delay the transer o distressed assets onto the market. This process will inevitably

speed up but or now will remain slow and torturous. However, the banking sector is by no

means the only source o investment grade product or the appetite o opportunistic investors.

Take, or example, the sello o EUR 25bn plus o real estate assets held by the German

openended unds in the process o liquidation.

This will give rise to two important trends. First, a signicant increase in investment product

rom distressed owners but second, and more importantly, the concentration o theseportolios will inevitably lead to an increase in pressure on pricing in specic sectors and

local markets. Over 80% o the European portolio o the German unds is in the oce sector.

Given that over hal o all the oce stock held by these unds is to be liquidated, the impact

on pricing will be signicant especially since oce transactions have made up less than

onethird o all investment volumes traded in Europe over the last ve years.

Most o these oce properties are held in Germany and France and, in these markets, we

do not expect there to be a signicant impact on pricing as the major markets in both

countries are liquid and likely to remain so in the oreseeable uture. However, the unds

also hold substantial portolios in the central and eastern Europe (CEE) and Benelux where

market conditions are dramatically dierent. Take the Netherlands or example, where

pricing is already under pressure, as vacancy levels continue to rise. In Amsterdam there is

now 1.1 million sqm o vacant space; an approximate 20% vacancy level. Onequarter o

these vacant oce buildings is owned by the same German unds and roughly 30% o the

vacant buildings are nanced by German bank loans.

The net result is inevitably a substantial all in oce values in a major European market and

signicant opportunities in terms o changes o use including the rezoning o oce space

that will never come back into productive use.


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Case study

There is no shortage o owners in denial

We recently saw the latest announcement o some o the progress made by governments in

recognising the hole they are in as well as an indication o how ar we still are rom nally

drawing a line in the sand.

By way o background, the rst hal o 2012 saw a dramatic all in investment activity in Spain

with just ve commercial sales closed in Madrid and Barcelona. This is not surprising given

that liquidity vanished in these markets as the economy deteriorated in Spain and investors

ocussed their activity on the larger, more transparent investment markets in core Europe.

The regional government in Madrid announced a disposal programme o a portolio in the

city which, as it turns out, is a good example o what we are likely to see in the comingmonths, as well as a great example o the act that many distressed owners have not yet ully

grasped the extent o the pain to come. The regional government will embark on a disposal

programme o about 100 assets with the rst round comprising the sale o 15 properties o

around EUR 62m. This process highlights a number o issues:

First, the relatively small lot sizes o the initial disposal programme. This could be

attractive to local investors in Madrid, particularly high net worth individuals, but is

unlikely to attract much interest rom international capital.

Second, because the disposal programme comes rom a public sector body, it will need to

adhere to a strict bidding process which can be long and cumbersome with considerable

risk that it may not actually be executed in the end. This too is likely to act as a deterrent

to international investors.

The third element is price. The Government is looking at a discount o 1520% on current

values. Such a level o discount is going to be wholly inadequate and, more than anything

else, refects the state o denial which continues to afict many o the distressed owners in

the region.

Similar portolios have recently been marketed throughout Spain, Italy and Portugal. Few

have transacted but only in cases where ar greater discounts have been secured. Pricing or

these types o assets will weaken urther and this market will continue to move in avour o

the opportunistic investor.


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Debt nancing

The pressure on the banks to shed real estate loans and assets will be a major issue or some

considerable time. The availability o bank nance in real estate will continue to dwindle(4). Banks

will come under increasing pressure to lend to the corporate sector and consumers, whilst

lending to real estate will continue to be seen as not just unprotable but marginal, given the

totality o the problem across the European economy. Real estate lending will continue to be

scarce and rationed to the two ends o the spectrum. Core investors will continue to access debt

albeit at lower loan to values (LTVs) and higher margins but so will opportunistic investors who

will be able to take advantage o stapled debt at the higher end o the risk spectrum(5). In both

cases, only good-quality sponsors will be able to access debt as banks not only consider the

quality o the investments but also the quality o the borrowers.

The stapling o debt is inevitable i banks are to succeed in cleaning up their balance sheets o

those assets that have been in suspended animation over the last ourtove years.

Exhibit 10 | Changes o UK banks net lending to property companies

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

GBP

millions

Source: Bank o England, as o June 2012


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Scarcity value

During the course o this real estate cycle, there has been a dramatic allo in new unds seeking to

raise capital in Europe. There are all sorts o reasons or this including the general level o risk

aversion, the troubled history o unlisted unds and consolidation in the industry, as well the eect

o new EU regulation which is beginning to take its toll on the size and nature o the investment

management industry. One unintended consequence o this is the comparative scarcity o credible

and experienced managers with the mix o nancial and operating experience required to create

value in this environment. Credible asset managers are rare, carry a premium, and will have a

considerable competitive advantage in the years ahead.

Exhibit 11 | Manager Experience is Scarce

0

5

10

15

20

25

2004 2005 2006 2007 2008 2009 2010 2011 2012

Billions

Real estate funds capital raising in Europe

Source: PERE, as o June 2012

Regulatory change also importantThe nature o the opportunity unolding across Europe comes not just rom the shock to the

capital markets and the distortion to the leasing market but rom the nature and pace o

regulatory change as well. The eect o Basel III and Solvency II have been well chronicled and

serve to quicken the pace o change amongst banks as well as other institutional investors. But

regulatory change is also beginning to have unexpected consequences as in the case, or

example, o the German governments position on the Alternative Investment Fund Managers

Directive (AIFMD). Implementation o the directive has prompted the Government to introduce a

clause into domestic legislation which, to all intents and purposes, discourages institutional

investment in new openended unds. The consequence o this will be increased redemptions as

investors take heed o the new legislation, and hasten the demise o such vehicles rom the

European investment market.


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The opportunistic market continues to

move towards the investor...The low appetite or risk amongst investors, the range and diversity o equity active in the

market, and the shrinking pool o debt nancing available has meant that pricing has and will

continue to move in dierent directions depending on where the investor sits on the risk

spectrum. The lions share o capital fows have targeted the core market and then only in the

largest and most liquid markets around Europe. This segment o the market remains highly liquid

and pricing remains competitive. Indeed, there are no bargains at this end o the real estate

market. Such a situation is in sharp contrast to the opportunistic market where there is not only a

surplus o supply o stock over demand but prices will continue to soten.

Risk Capital/stock balance Key themes/rationale Liquidity Pricing

Trophy assets Excess demand over supply

Strong global equity ows

Long term horizon

Wealth retention

Reliable income

Liquidity

Very liquid Fair value

Core Excess demand over supply

Increasing supply (Banks and OEFs)

Mix o domestic and global capital

Debt is available

Rental growth

Stable income

Liquid Fair value

Midrisk Excess demand over supply

Increasing supply

Leasing uncertainty

Little debt available

Mispricing o risk

Illiquid Mispriced

Opportunistic Excess demand over supply

Increasing stock rom banks/OEFs

Little debt available

Distressed sellers

Capital market shit

Signicant discounts to book value

Regulatory change

Liquid at a price Mispriced



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An opportunistic investment strategy

or EuropeGiven the level o continued uncertainty in the market, the shrinking pool o CRE debt and the

prospect o little or no growth on the horizon, an opportunistic strategy or the European region

has to be ounded on our key elements:

1 Extreme risk aversion

The market conditions that have characterised this market cycle have led not only to a level o

extreme risk aversion with a complete ocus on core, but more importantly to a redenition

o core itsel. Unless the asset meets narrow criteria in terms o location, asset quality, length

o lease or covenant, it will tend to all outside the institutional market or which there is ample

liquidity. The market has overreacted and the net result is a large swathe o good quality andinstitutional real estate that has been temporarily let high and dry. It may be that such assets

have a little vacancy, or the lease length may be on the cusp o what is deemed acceptable

minor impairments that can be rectied through an injection o resh capital or the active

management o the asset itsel. These assets are now being priced as secondary, but will re-

price as the market takes stock.

2 Recapitalisation

The balance sheets o European banks may be stued ull o distressed assets, yet only a trickle

has come to the market. Frequent injections o liquidity have provided something o a saety net

or banks that simply have not been orced to sell in the current conditions. It has allowed banks

to hold onto those assets that continue to cover interest payments and where, basically, the bank

is more than happy to simply collect the coupon.

However, there is another, much larger group o assets on bank balance sheets which are

languishing and whose values are deteriorating by the day. These properties need capital and

management but have been in suspended animation or a considerable time. The borrower

having lost most, i not all o his capital and the lender with inadequate asset management skills

and an unwillingness or inability to invest are aced with a pool o assets whose value is

deteriorating at ever increasing speeds. These are problematic assets whose impairments can be

ameliorated through the deployment o resh capital and/or handson active management.

3 Divergence is mispriced and undervalued

The European market is priced as i it was a single entity. But nothing could be urther rom the

truth. Not only did the downturn lack any real synchronicity but the pattern o perormanceand the outlook or recovery continues to show a considerable degree o divergence. The degree

o polarisation will increase allowing opportunistic investors to seek value at both ends o a

polarised market.

4 Asset management

Most important o all, the sort o opportunistic investment market unolding in Europe is unlike

anything in the past. The key driver o returns has shited rom the ability to deploy debt to the

quality o the investment manager. Their credibility, track record and handson operating experience

will be the key dierentiating actors in this new investment cycle.


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Opportunity I - Extreme Risk Aversion

Definition of Core

Attractive pricing

Yield spreads

Risk aversion has led not just to a flight to core but a re-definition of low-risk assets. The investmentuniverse for core assets has shrunk resulting in a universe of institutional assets in major markets that

are currently being priced as secondary. A group of assetswhich have minor impairments capable ofbeing rectified by an injection of capital and/or active management.

The opportunity to acquire good quality assets at historically attractive pricing and, in a segment of themarket, which will continue to be characterised by limited competition.

Yield spreads between prime and secondary, tier I and tier II markets as well as between core andperipheral Europe are at an all time high. These will correct and markets will re-price as Europestabilises over the medium term.

Opportunity I - Extreme risk aversion

Definition of core

Attractive pricing

Yield spreads

Risk aversion has led not just to a flight to core but a re-definition of low-risk assets. The investmentuniverse for core assets has shrunk resulting in a universe of institutional assets in major markets that

are currently being priced as secondary. A group of assets which have minor impairments capable ofbeing rectified by an injection of capital and/or active management.

The opportunity to acquire good quality assets at historically attractive pricing and, in a segment of themarket, which will continue to be characterised by limited competition.

Yield spreads between prime and secondary, tier I and tier II markets as well as between core andperipheral Europe are at an all time high. These will correct and markets will re-price as Europestabilises over the medium term.

Opportunity II Recapitalisation

Capital structures

Capital starvation

Suspended animation

Fixing capital structures through fresh injections of capital. There is an increased recognition by existingowners and the banks of the need to exit, or partner, at realistic prices.

Quality real estate managers in both the public and unlisted markets are in increasing need of freshcapital. This will become particularly evident as bank activity shrinks back into their respective domesticmarkets. The result will be a significant starvation of capital, particularly in regions such as the CEEand Benelux.

Whilst banks have been holding on to real estate on their balance sheet, they have neither activelymanaged nor supplied the sort of capital required to sustain value. There is, therefore, an opportunity toacquire assets which have been in suspended animation for the past four-to-five years and starved ofcapital and operating expertise.

Structured finance

Special situations

Provision of financing above that of the senior lender. Structured investments with the opportunity toparticipate in future capital appreciation.

Opportunity III Divergence is mispriced and under-valued

Economic polarisation

Tight leasing markets

Structural vacancy

Whilst regional growth will be modest and rather anaemic, the outlook at a city level will continue to bepolarised. Some of the largest and most dynamic centres have remained resilient to the downturn andshow a positive outlook in terms of rates of growth and net positive absorption going forward.

Over the medium term, there is likely to be strong demand for development and refurbishment activityable to deliver the type of modern space capable of meeting occupier needs. The European market willbe characterised by a shortfall in quality stock over the next two-to-three years.

Whilst vacancy remains low in the major markets, there are a number of other important markets whichare subject to structurally high levels of vacancy. This will provide the opportunity for changes of useparticularly in cities with a strong demographic base and high quality of life index.

No macro riskIncreasing polarisation and little or no growth will preclude investors from taking macro positions inthis phase of the opportunistic investment cycle. The strategy has to be highly focussed and selectiverather than taking a macro position on a particular region or sector.

Opportunity IV Value creation by asset management

Hands-on experience

Sourcing of

transactions

Credible manager

The asset manager will be the main driver of investment returns in this cycle. The manager has to havethe operating and financial expertise required to drive returns against a background of substantiallyless debt and rates of economic growth.

The ability to source transactions and leverage local relationships to achieve competitive advantagewill be critical in determining a successful opportunistic investment strategy.

The track record and credibility in the market of the investment manager is crucial not just in beingable to access debt but in reducing the level of execution risk associated with complex transactions.

Scarce resources

This mix of operating and financial experience required to drive returns is increasingly scarce followingthe turmoil of the last few years, and the impact of regulatory change which will speed up the pace ofconsolidation in the investment management industry. Those constraints on capital and operatingexperience provide an attractive environment for pro-active managers.

Entity level restructuring and public to private activity. Raising new capital is both dicult and dilutivewith equity markets remaining volatile and the majority of real estate companies trading at a significantdiscount to NAV.



19/20


Footnotes

(1) Typical denition o investment styles according to the European Association or Investors in

NonListed Real Estate Vehicles (INREV).

Investment style

Core Mid risk Opportunistic

Total return

expectations68% 811% 15%+

LTV 60%

Timing Highly sensitive to

market cycle

Sensitive to

market cycle

Less sensitive to

market cycle

Market access Competitive bid Mainly ofmarket

RiskMinimal leasing risk,

lease expiries and

capex requirement

Modest leasing and

vacancy risk. May

included light

reurishment

May include

reurbishment and

groundup

development risk

Holding periodLong tem hold

(10 years+)57 years

Short tem (23 years)

with active trading

strategy

Driver o valueIncome growth

Balance between

income and capital

Mainly driven by

capital appreciation

Income driver >60% 50%


20/20

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