Commercial property investors in Europe seem to have found a new passion. Listing – pioneered by the American export of real estate investment trusts (REITs) – is an increasingly popular proposition across the continent. From being a ‘wishful thinking’ scenario in the margins of business planning, taking a real estate portfolio public has grown to become a dominant strategy.
As the market cycle progressed, the prospect of further yield compression became increasingly scarce. Competition among investment managers meant that it was no longer sufficient to assemble a portfolio or buy underpriced assets and wait for buyer competition to do its magic. Investment managers across all sectors needed to become ever more creative in order to beat competition, showcase their success and achieve alpha returns. Financial markets have, therefore attracted an ever greater number of investment funds. Making real estate investments liquid, widening access to capital, increasing investors’ transparency, and lowering the cost for Joe to access commercial real estate investments, are the main points in favour of taking a property company public.
The practice of taking real estate companies public has been around for a while, and some of the largest property investment companies in Europe are listed on one of the continent’s major exchanges. However, the scope and economics of listing has recently broadened significantly. A successful listing would previously require a diversified property portfolio of at least $1 billion across a range of sectors and geographies. The impetus of the market, and the continuous inflow of capital from a greater number of sources, has significantly lowered this bar. New investors have both increased the appeal of listings in Europe and provided access to new, exotic financial markets, whose stock market investors are eager to bite into the European property sector. In a much-publicised recent property listing, for example, Echo Polska listed with a portfolio totalling under 450,000 sqm of space across just one and a half dozen properties.
For investors - and the managers of their portfolios - it is not difficult to gauge why listing is becoming so popular. With European REITs offering an average dividend yield of below 4% against unlevered prime yields reaching 7%* in major European capital cities, the profit margin is more than appealing. Even allowing for distribution allocations and the cost of being a public company, the potential gains of exiting and investment via public listing are large. Taking into account the true returns on property - adjusting for leverage and portfolio diversification though secondary properies and value-add investments - it may seem strange that it took so long for listings to look enticing. Yet, the increasing popularity of the financial market among the property investment community is more than a sign of temporary, peak-of-the-cycle investor excitement. It is a sign of greater maturity of the European investment market.
These developments should be welcomed, albeit cautiously. European property markets lag far behind those of the US and the Far East in the diversification of capital sources. Investment activity across Europe has relied too heavily on private, local debt and traditional bank lending. Greater reliance of financial markets will lower the cost of capital by giving those investors with hundreds of millions, rather than hundreds of billions, more options to structure transactions and open up new opportunities. The only downside is that - even with heavier regulation - the transfer of risk onto small shareholders, especially those with no prior knowledge of real estate in places they have barely heard of, removes investment managers’ accountability. By increasing the pool of available capital faster than the manager’s ability to identify the best transactions, the pressure to invest will increase the investors’ propensity to take risks and may ultimately lead to suboptimal investment decision-making.
*CBRE, Cushman & Wakefiled, JLL, Knight Frank