During periods of volatility and market turbulence the market seems to exhibit an irrational excitement about available investment prospects. However, after a few years of growth, and following what many believe to have been peak activity in 2016, increasing attention is being paid to various forms of “exit”. This is not only about the impact of the UK and US exits from the EU and Paris climate agreement respectively, but also about the more ordinary prospect of completing an investment cycle and owners cashing in when the time is right. Listing is one of the more common ways to achieve an exit and validate the strategy. According to the European Public Real Estate Association (‘EPRA’), the European listed real estate sector was worth $448 billion as of Q2 2017, with seven IPOs taking place during the quarter raising over $1.2 billion in total. In addition to the established markets of the UK, France and Germany, Real Estate Investment Trusts are increasingly appealing vehicles for private companies to evolve into in Italy and Spain.
In this respect, investment managers are thinking about exit in two main ways, depending on exactly where they are in their spending cycle. For those under less pressure to grow, if the market peak has just passed, should they be cashing in on the profit made? But for those who are under more pressure to invest and grow their portfolio, will they be able to exit for a profit and yet meet their business plan?
Investment managers look to cash in on their hard won investments and validate their investment prowess, in order to enable them to, well… do it all over again. The need to time the market perfectly is obvious, both allowing investors to earn their keep in a competitive money market, and producing the direct monetary rewards which tie managers in until the end of an investment. Exit is what keeps the property investment industry alive and well.
The investment process however, is a zero-sum game. Even when both sellers and buyers leave the table smiling, after what both believe to be a lucrative deal, the inherent asymmetry of information suffered by other stakeholders in the property investment process – usually the occupiers and less frequently the developers and lenders – guarantees that someone will lose out.
Even for long-term leases, once value is maximised by improving the physical characteristics of a property, ensuring all space suitable for occupation is let, and that a tax-minimising, return-maximising capital structure is in place, there remains an ultimate perception of property as a deteriorating asset, so the pressure to sell is high. Careful consideration of where the market is, and whether purchasers are likely to pay top dollar at exit, is key.
The motivation for exit is a crucial factor in the work of investment managers. In another industry that is most dependent on exit, private equity, general partners (‘GPs’, investment managers – aka those who have more time than money) need to ensure the limited partners (‘LPs’, investors – aka those who have more money than time) meet their investment targets, while being reasonably compensated themselves.
In this process LPs want to suitably incentivise their GPs while ensuring that an excessive layering of fees does not eat into their own net returns. In this game of cat-and-mouse, GPs only survive is they are in constant motion: competition requires that they continually search for new capital or the best buying and selling opportunities.
A failure of a GP to exit at the right time and thereby fail to beat the market, or, worse still, fail to deliver returns promised to LPs, can be fatal. Timing the market perfectly is as hard as predicting the future. More often than not, luck plays a greater role than professionals care to admit.
In the coming months and quarters, as discussions about exit and strategy become increasingly prominent, timing the market will become even more difficult. For, as yields reach record lows in a growing number of markets, and the influx of overseas investors continues to drive megadeals across Europe, there is a real risk that investment fundamentals will diverge from sustainable levels – thereby undermining the delivery of a strong investment strategy. This is bound to mean a shake up for many a well-planned real estate strategy.