Investors must dig deeper to unearth opportunities in today’s real estate market
As Property EU reported in January, an abrupt reversal in monetary policy from central banks wrong-footed investors expecting a tightening of interest rates in 2019.
There will be no repetition in 2020 though. Central banks across the world have slashed rates in the face of COVID-19. The possibility of returning to levels seen just two months seems remote.
‘Lower for longer’ has become ‘lower for even longer’. What does this mean for real estate investors? Although valuations and liquidity will suffer in the short term, when COVID-19 abates, we expect that the economic stimulus will drive real estate prices higher as investors chase the comparatively higher returns versus bonds.
The problem is that even with a slowdown priced-in, ten or so years of low rates has depressed supply and opportunities for organic and/or rental growth. So, where are the opportunities to make returns?
Broadly speaking investors can adopt one of two approaches - reduce the quality of assets, or acquire high-quality assets but through more complex structures such as funds or listed vehicles. Our conviction is that due to dislocation between the public and private markets, the latter offers better relative value while remaining defensive - it does not compromise on quality of the underlying assets.
The acquisition of control stakes in small and mid-cap publicly listed real estate companies, funds and REITs typifies the second approach. REIT regimes for example have led to enormous growth in the quantities of publicly listed real estate. From 1990 to date the allocation of the MSCI World global equities index to real estate has expanded almost 300%.
Many of these companies are however sub-scale and closely-held, with weak equity stories and hence trade at significant discounts to net asset value (NAV). Furthermore, as NAV is assessed by valuers, uniform valuation standards do not always apply. This often leads to significant discrepancies between public and private market valuations.
Traditional property investors often over-look these companies. While on the one hand they understand the underlying assets, they often lack the corporate finance expertise required to operate in the public markets. This includes the myriad of laws and regulations around insider dealing, public versus private information and takeovers.
At the same time, the small and mid-cap public real estate companies are often too small to be on the radars of hedge funds and private equity groups. Correspondingly, while they will be well-versed in the public markets, they will lack fundamental real estate expertise.
Rivercrown’s unusual combination of real estate and public markets expertise led it to acquire a control stake in Maxirent, in late 2019. Maxirent is a Euronext-listed closed-ended real estate fund that was established in 1993. Maxirent has a gross asset value of in excess of €100m of which more than 90% is concentrated in 9 high-quality assets in Lisbon.
We have identified similar opportunities in France, Germany and Portugal. But as well as the requisite expertise, investors pursuing such opportunities need to have the appropriate skillsets and be prepared for protracted, complicated negotiations and planning. The shareholdings in target companies are usually held by a small handful of investors, and traded infrequently. Management is often not aligned with independent shareholders and so potential investors need to be armed with the tools and strategies to tackle these issues both pre and post-acquisition.
Non-performing loans (NPLs) are another area where the adoption of additional complexity can yield better than average risk-adjusted returns. The value of NPLs on European banks’ balance sheets is estimated at approximately €300 billion, having peaked at €1.4 trillion in 2014. But the times for easy pickings of larger and more liquid positions has long passed. Opportunities will exist in acquiring assets from the “tails” of these transactions particularly as enforcement processes, creditors rights and hence recoveries are expected to deteriorate considerably due to COVID-related macro-economic factors as well as governments’ corresponding attempts to protect debtors. The approach of pro-active and opportunistic sourcing and rigorous underwriting are expected to yield results.
We believe that these opportunities will be pronounced in the ‘late cycle transactions’ those of 2018 and 2019 vintages, substantial balances of which remain outstanding.
Now more than ever, real estate investors must look beyond the well-trodden path for the best opportunities. However, securing these requires taking-on added complexity. This can only be possible by combining diverse skillsets, painstaking research and thorough due diligence.
Stephen Benson and Jacob Lyons are Founders and Managing Directors at Rivercrown