European Quarterly October 2008
European real estate:
coping with market turmoil Over a year since the sub-prime crisis first broke, it is to be hoped that, looking back, the unprecedented market turmoil of September 2008 will be seen to have marked some kind of turning point. At the time of writing it is impossible to say how the latest dramatic developments will pan out, but what does seem clear is that the gravity of recent events have forced a sharp change in the US authorities’ approach to the crisis.
Page 4 CEE – Weathering the storm Page 7 Equity-driven Canadian funds targeting European markets Page 10 Market focus: a look at markets currently in investors’ sights Page 12 Notable deals
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After allowing the failure of Lehman brothers, ostensibly to draw a line under further government support following the bail out of the two giant mortgage agencies Freddie Mac and Fannie Mae, the authorities were forced into a U-turn only a day later in order to prevent the imminent collapse of AIG, with potentially catastrophic implications for the financial system given the latter’s exposure to the huge credit derivatives market. Amid continuing market volatility, which has seen a dramatic flight to quality (three-month US treasury bill yields falling to their lowest levels since 1941), a renewed squeeze on liquidity, concerns over confidence in US mutual funds and, in the UK, the forced acquisition of HBoS by Lloyds TSB, the US authorities now look to have abandoned their earlier reactive approach to unfolding events. Instead, a sweeping programme of intervention is apparently being prepared, which will involve the use of public funds to purchase distressed assets, hopefully alleviating the log jam in credit markets and beginning to restore confidence in asset backed securities. We will have to wait to see how this new phase of the crisis unfolds, but the repercussions of the past year’s events will weigh heavily for some time on the European real estate investment market even under the most favourable scenario. In particular, credit conditions faced by investors are set to remain tight, with the exit of two major lenders,
Lehman and HBoS only exacerbating the problem. Lenders will continue to struggle both to repair balance sheets hit by sub-prime related losses and to cope with reduced liquidity in the wholesale funding markets, whilst a substantive recovery in the CMBS market in Europe seems further away than ever, especially in the light of potential further distressed asset sales in the wake of recent market developments. For real estate of course, reduced lending capacity has been exacerbated by a re-rating of the sector in the face of falling capital values and prospective (though not yet actual) tenant defaults, prompting a marked tightening in lending terms and conditions. Going forward, much may depend on the approach adopted by lenders towards borrowers in technical breach of loan terms but nevertheless continuing to service their debt. The shock to capital markets triggered by the sub-prime crisis and its direct impact on the real estate investment market has of course dominated investor concerns over the past year, with the UK market leading a sharp correction in capital values, down more than 20% since their peak in June 2007. Initially, the main impact on occupier markets was felt primarily via the financial sector, with markets such as London City already seeing declining rental values as job losses in the sector grow and occupier demand weakens, a trend which can only be exacerbated by recent problems
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DTZ’s contacts A selection of our international team members
European real estate: coping with market turmoil continued
John Slade +44 (0)20 7757 6685 john.slade@dtz.com Chairman Capital Markets
Timo Tschammler +44 (0)20 7643 6293 timo.tschammler@dtz.com Managing Director International Investment
Paul Abrey +44 (0)20 7643 6115 paul.abrey@dtz.com Director International Investment
Andrew Barnicke +1 (416) 865 4664 andrew.barnicke@ dtzbarnicke.com Senior Vice President DTZ Barnicke
Doug Hardman +36 1 472 7206 doug.hardman@dtz.com Director Central & Eastern Europe
Paul Sanderson +44 (0)20 7757 6880 paul.sanderson@dtz.com Director DTZ Research
in the sector involving Lehman and HBoS. In the months ahead, however, real estate investors’ attention is likely to be increasingly focussed on the wider repercussions of the credit crunch on the real economy and thus occupier markets, and here the picture is at best mixed. Whereas the US economy has if anything held up better than might have been anticipated in recent months, helped by the Fed’s aggressive action in cutting interest rates, the depreciation of the dollar and an $150bn package of tax rebates, weakening export growth and faltering investment caused growth in the major European economies to turn negative in the second quarter. In contrast to the Fed, the ECB, and to a lesser extent the Bank of England, have been constrained in cutting interest rates by oil and commoditydriven pressures on inflation, and with some economies, notably the UK, Spain and Ireland, experiencing sharp housing and construction slowdowns, it may be core Europe, rather than the US economy, which is first to fall into recession. Conditions remain more buoyant in Central and Eastern Europe, but even here (as the article on page 4 indicates), risks, both political and economic, are growing. Against this background, activity in the direct investment market across Europe has continued to weaken over recent months, with transactions totalling c.€33bn in 2008 Q2, down some 45% since the peak in the market a year previous. The decline would have been still sharper if it had not been for the massive Vasakronan portfolio deal in Sweden, worth some €4.35bn, although difficult financing conditions have meant that deals of this type have been very much the exception in recent months, with large lot sizes of €200m and above taking a decreasing share of the market. Apart from financing conditions, a dislocation between buyers’ and sellers’ price expectations remains the main constraint on deals. It is perhaps significant that whilst yields are moving out in most markets, it is in the UK, which led the correction, where market turnover appears to have at least stabilized,
albeit at depressed levels compared with a year ago. Whilst the major domestic institutional players continue to hold back, overseas equity-based players such as German OEFs, sovereign wealth funds and Middle East private equity have become more active, targeting prime, primarily London-based assets. Substantial re-pricing is currently also taking place in Spain, the Nordic countries and in the French markets (Paris CBD), accompanied by some recovery in transaction volumes in the latter. Elsewhere, markets have been slower to adjust, but a consequence of this has been a continued slide in market turnover. This applies in particular to the German market, where domestic investors have increasingly sought value elsewhere. Where do we go from here? The market is moving closer to fair value as yields adjust, and investment opportunities will increase as this process continues. In a more risk averse, credit-constrained world, the relative premium on prime assets is likely to widen, with secondary assets particularly vulnerable to yield correction. We may also see some unwinding of the general convergence of yields across European markets which has taken place in recent years as investors focus more closely on potential risk-adjusted returns. This will make for a challenging investment environment over the rest of this year and into 2009, with underlying occupier fundamentals (and effective asset management) vital given limited scope for capital growth. Against this background, a fall in European investment volumes of some 40% seems likely this year. The inevitable return of equity-based investors, whether opportunity funds or more traditional players, is key to the market’s recovery, but its timing is likely to be heavily dependent on some indication that the worst of the turmoil in financial markets is finally behind us.
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Market insight Investment volumes:
The real estate investment market continued to struggle in Q2 2008, with total volumes falling for the fourth consecutive quarter to reach €33 billion, 10% down on Q1. Whilst the rate of decline in market activity may be slowing, transaction volumes were nevertheless 40% down over the first half of the year compared to the same time in 2007.
Lot sizes:
With tight access to financing, large-scale portfolio deals such as the Vasakronan deal are increasingly rare, reflecting the lack of liquidity and confidence in the market, this trend has been especially marked in Germany, the UK, France and Spain, where the average transaction size now falls close to the European average (see chart bottom left). Some investors are splitting up portfolios when they sell them in order to optimize the value of their assets.
Cross border activity in Europe accounted for 40% of total investment in Q2 2008, compared with a peak of 56% seen in Q2 2007. In Q2 German investors were particularly active, accounting for c. 20% of cross border deals. Over 60% of all European purchases by German investors were cross border in Q2 2008, compared with c. 20% in the same period of the previous year. In London, foreign investment activity is on the rise as yields – especially in London City – begin to look more attractive. Middle-Eastern and German investors purchased almost €2 billion worth of property in the UK in Q2 2008. Lancer Asset Management, backed by the Abu Dhabi royal family, purchased two former Thistle hotels in Knightsbridge at c. € 400 million from UK based Candy & Candy. German open-ended funds remain active in London and have placed offers on a number of properties in the City exceeding €600 million in total. In France, yields are adjusting, and, investment activity has picked up, with total investment volumes reaching c. €3.6 million in Q2 2008. At the end of June, the private
Hexagone Fund, managed by DTZ and Morley Asset Management, acquired the sought-after Sapphire portfolio (comprising offices and light industrial assets) for €84 million. While German open-ended funds have been seeking value across Europe, they have been far less active in their home market, where investment opportunities have been limited. Investment transactions in the German market as a whole fell sharply to total only €4 billion in Q2 2008, down 50% on Q1.However, yields have started to move out and foreign and domestic investors are expected to gradually return to the market. In Spain, total investment volumes declined to €1.1 billion from €3.6 billion in Q1 20081, with only one deal above the €100 million mark. However, yields are correcting swiftly and transactions recorded in the past few months indicate that prime office yields are now c. 150-175 bps higher in Madrid compared to Q1 2007. As domestic property companies struggle to refinance loans and offload their assets to restore liquidity, foreign equity-strong investors will be well placed to take advantage. 1
The decline is largely due to the major Santander deal in Q1 2008 (€ 1.9 billion)
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CEE – weathering the storm While hardly immune to the ravages of the global credit crisis, the CEE region has proven fairly resilient. Yet a “flight to quality” pervades the investment markets as yield compression gives way to the fundamentals of rental growth and asset management.
In many ways, the economies of Central and East Europe (CEE) and Russia have never had it so good. Between 2003 and 2007, the average annual GDP growth rate in the advanced Central European countries (Poland, Hungary, Czech Republic and Slovakia) was 5.1%, compared with 6.2% in Romania and Bulgaria and an even brisker 7.6% in Russia and Ukraine. This contrasts with 2% in the Eurozone and 2.9% in the UK. While some economies have slowed markedly, with the Baltic States and Hungary experiencing the sharpest downturns and Russia’s financial sector has been one of the hardest hit, strong domestic demand, notably in the large consumer markets of Russia and Poland, and a surge in private capital flows (€240bn in 2007) have fuelled the boom. With the exception of Hungary, the average annual GDP growth rate among the region’s main markets in 2008-09 is expected to reach 5.5%. Yet having powered ahead in the benign global economic conditions of recent years, CEE and Russia now face their sternest test yet as the turmoil in international credit markets and a sharp rise in inflation threaten to dampen growth.
CEE economies are a diverse group The credit crunch has exposed sharp differences among CEE economies, particularly regarding the amount of capital they need to raise on the international debt markets. Five-year Credit Default Swap (CDS) spreads, the most closely-watched measure of sovereign risk, were still below 90 basis points in Poland and the Czech Republic at mid September, mainly because of the two countries’ relatively low external financing needs. However, in Kazakhstan, Romania and Bulgaria, CDS spreads increased dramatically to between 240 and 655 basis points. All three countries are exposed to financial risks stemming from colossal current account deficits (21.5% of GDP in Bulgaria), rapid credit growth and a large build-up of foreign currency-denominated loans. In Russia, the geo-political fallout from the war in Georgia
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and the ensuing turmoil in the country’s financial markets have increased domestic borrowing costs significantly, adding to fears over a surge in inflation. In one sense, the region’s economies are relatively insulated from the credit crunch because of their low levels of household and corporate indebtedness, a reflection of a relatively underdeveloped financial system. Even in the more developed Central European markets, banking penetration is still relatively low, with loans and deposits as a share of GDP still only one third as high as in the Eurozone. On the other hand, a low savings ratio, while fuelling the consumption booms that are driving robust GDP growth across the region, has forced some CEE countries to rely heavily on inflows of short-term foreign capital, making them potentially vulnerable to shifts in investor sentiment or tighter market conditions.
A changed investment landscape The commercial property investment markets in CEE and Russia have changed markedly since the credit crunch erupted in August 2007, most notably in terms of the investor base and the criteria underpinning stock selection. Trends which were visible, particularly in the more mature Central European countries, before the financial crisis hit - limited scope for further yield compression, inferior secondary assets warranting higher risk premia and a growing emphasis among purchasers on property market fundamentals - have come to the fore over the past year and will become more pronounced as the price correction in the region takes hold in the second-half of 2008 and 2009. In 2007, transaction volumes in CEE reached €13.5bn, up 36% on 2006 and amounting to 6.4% of the total volumes transacted across Europe last year. In H1 2008, investment activity in CEE fell to only €4.1bn, 40% lower than in the same period in 2007 and 37% down from H2 2007. While the Polish and Russian markets remained strong, with Russia
benefiting from KanAm Grund’s landmark acquisition of the Paveletskaya office buildings in Moscow for €603m, transactions in the Czech Republic and Romania fell precipitously. However, there has been recent indication that investors are returning to the market, one of them being DEGI, part of the Aberdeen Property Investors Group having signed a contract to purchase the Iris Shopping Centre Titan in Bucharest, Romania, for €140 million. As is the case in Western Europe, the economics of commercial property investment across CEE have turned sharply against the more highly-geared buyers. Since the credit crunch hit in August 2007, German openended funds have significantly increased their exposure to CEE and are responsible for a large portion of the region’s transactions. Aside from KanAm Grund’s purchase in Moscow, other notable deals involving German funds include DEKA Immobilien’s purchase of the Andersia Tower office building in Poznan for €80m and DEGI’s acquisition of the Andel Palacemixed-use in Prague for €57m. DTZ was the adviser for DEGI.
Sovereign CDS Prices
CEE – foreign investment by nationality
On a risk-adjusted basis, given the increase in funding costs since August 2007 and the swift re-pricing of the UK market, prime yields in CEE, which hit record lows in Q2 2007, are looking less attractive than in 2005 and 2006. Still only marginally higher in the Central European capitals than before the start of the credit crisis, prime yields have been slower to correct because of the relative immaturity and inefficiency of CEE markets, resulting in a lengthier re-pricing of risk. However, we believe that the current uncertainty over pricing in the region is prima facie evidence that a correction is taking place. We expect a further outward shift in prime yields in the main CEE capitals of at least 100bp by the end of 2009, with yields on secondary assets moving out much further as the fundamentals of current income, location, sustainable rental growth and covenant strength take on their rightful importance in stock selection. Yields in Kiev and Bucharest have already moved out by at least 80-115bp.
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CEE – weathering the storm continued
Quarterly investment transactions in CEE
Occupier markets remain robust The buoyancy of CEE economies and the benign outlook for GDP growth in 2008 and 2009, despite an increasingly grim economic climate in the Eurozone, provide strong support to the region’s occupier markets. While London has borne the brunt of the US sub-prime fallout, Warsaw, Budapest, Bucharest, Kiev and Moscow all recorded their strongest office takeup levels to date in 2007, with demand in Bucharest exceeding 24% of the capital’s total office stock in 2007. Prime rents in all five capitals, with the exception of Budapest, increased significantly, ranging from 15% in Bucharest to circa 90% in Moscow. Russia’s booming capital has quickly emerged as Europe’s most dynamic office market, with 250,000 sq m of space being let in Q1 2008 alone, after a record 1.5m sq m of take-up in 2007. Rental growth in Moscow will moderate in 2008, but is expected to increase by circa 25% given the continued imbalance between supply and demand. Modern office space per head in Moscow is still only 0.5 sq m – roughly one-third that of Warsaw and one-sixth that of London. In the retail sector, development activity across CEE, particularly in the larger consumer markets, continues apace, buoyed by strong increases in purchasing power. Retail sales in Romania, Russia and Ukraine grew between 15% and 25% year-on-year in H1 2008. Traditional retail channels are giving way to modern formats, creating strong demand for shopping centres with increasingly sophisticated design concepts. In 2007, office and retail sectors were the best-performing sector in CEE in terms of rental growth and total returns, significantly outpacing Western Europe. Rental levels have stabilised in the Central European markets but are expected to keep rising in Kiev and Moscow in the short to medium term as these markets still lag behind in terms of supply. While Russia has the largest shopping centre development pipeline in Europe, we expect lower availability of credit in 2008-09 to curb development activity somewhat, supporting prime rents and putting more emphasis on sophisticated design.
The industrial and logistics markets across CEE are the direct beneficiary of the region’s consumption booms, the shift in manufacturing activities to lower-cost countries and, crucially, large EU-funded infrastructure projects designed to integrate the region into the EU’s transport networks. The Balkans are emerging as a major transportation hub between Europe and Asia, with the port of Constanta in Romania now one of Europe’s fastest growing ports. We expect Poland, the Czech Republic, Romania and Russia to offer the best opportunities for logistics operators in the short to medium term, with a broadly stable rental outlook given limited speculative development.
Focus on fundamentals Looking ahead, CEE countries will, for the first time since the region’s property investment market took off in 2003-04, have to adjust to pricing levels based mainly on underlying occupier fundamentals as opposed to capital appreciation. We believe the yield shift across CEE has only just begun and is lagging behind the UK partly because of the lower degree of leverage in the sector, delaying the correction and thus prolonging the mismatch in price expectations between buyers and sellers. The limited prospects for capital growth will make occupational markets critical to adroit stock selection. On this basis, the solid underpinnings of CEE occupier markets create investment opportunities, albeit favouring equity-led buyers. The larger markets, which are still severely undersupplied, are less reliant on external demand and have significant secondary city potential, remain attractive, particularly in the retail sector. The macroeconomic underpinnings of the region will, however, need to be closely monitored given the expected slowdown in GDP growth in 2008-09 and the spike in inflation which is already showing signs of eating into incomes, partly through an accompanying rise in interest rates.
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2810 Matheson Boulevard East, Mississauga
Equity-driven Canadian funds targeting European markets Last year, Canadian investors directly acquired more than $10 billion in property outside their borders, with significant recent transactions in the UK, Germany, France and Russia, as well as Australia and the US. What is driving this record level of investment outflow from Canada to Europe and the rest of the globe? Conversely, is now the time for European investors to consider investment opportunities in Canada?
GDP and employment growth in EU and Canada
While Canada has not been immune to the global economic slowdown that has dominated the headlines in 2008, it is coming off a period of exceptional growth, with unemployment hitting a 33-year low in 2007 and the currency experiencing an unprecedented 24% increase against the US dollar. While economic performance has decelerated in 2008, as evidenced by weaker GDP and employment figures, it has varied by region. Canada is a resource rich country with a wealth of commodities like uranium, potash, natural gas and oil at a time where the demand for these commodities is greater than ever. Canada’s oil reserves, mostly held in the oil sands of Alberta, are second only to Saudi Arabia, providing 46% of its oil production and expected to grow to 80% by 2020. Roughly 71% of the nation’s oil production is exported to the US, and 2007 marked the first time that the US imported more oil from Canada than from the entire Persian Gulf region. In fact, oil exports to the US have nearly doubled since the early 1990s, adding to Canada’s long-running annual global trade surplus. With oil prices still high, the natural resourcerich Western Provinces are outperforming manufacturing-based Central Canada. Perhaps, then, it comes as no surprise that even as 2007’s credit crunch has continued into 2008, Canada’s property investors are still grabbing headlines in Europe and around the world. Lowly geared Canadian funds are looking to pick up good buys in liquiditypressured Europe, where investors with an abundance of equity are few.
Pensions lead the way: Canada’s retirement system fuels property investment abroad Of the world’s 300 largest pension plans, 20 hail from Canada, ranking third behind the US (140 plans) and the UK (29) in terms of the number of large plans, In fact, the two largest plans in Canada both boast assets in excess of $100 billion, far larger than the biggest plan in the UK, and compound annualized growth
of Canada’s share of the top 300 funds is second only to Australia. Many of these funds have significant allocations to real estate. In all, Canada’s various pension funds together control roughly $1 trillion in invested assets, equivalent to 79% of GDP, up from 56% in 1997. Their property allocation reached a high at the end of 2007, touching 7%. But most pension funds are aiming to increase their real estate holding to a value equal to 10-15% of their investment portfolio. A 5% increase of real estate holdings to 12% of current assets would potentially correspond to a further inflow to property of C$50 billion, of which a significant part would be invested outside of Canada. While individual funds are governed by their own set of funding priorities, provincial government legislation and investment guidelines, potential future funding shortfalls have encouraged a general revision of investment strategies and asset allocations over the past decade aimed at increasing investment returns, opening the path for greater asset class diversification, including real estate. In order to do so, many of Canada’s larger funds have created investment boards or fund managers to oversee the allocation of investments and ensure a balanced portfolio. For example, the CPP Investment Board (CPPIB), the investment arm of the Canada Pension Plan, has grown from a $35 billion portfolio to $127.7 billion, one of the largest and fastest-growing single-purpose funds in the world and the largest single-purpose pool of capital in Canada. CPPIB is on track to rival in asset size the Caisse de dépôt et placement du Québec, which oversees investment for 25 of Québec’s various public and private pension and insurance plans, Meanwhile, oil-rich Alberta recently consolidated its various pension plans and other funds under the auspices of a newly-created Crown Corporation, the Alberta Investment Management Corporation or AIMCo, which boasted $70 billion in assets at its inception in 2008. Given Alberta’s extraordinary natural
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Central Station Complex (CSC), Montreal
Canadian pension fund assets, 1993–2007
Canada’s largest pension funds/fund managers Name
Total Net assets under management ($billions)
Current allocation to real estate
Caisse de dépôt et placement du Québec).
$155.4
10.1%
CPPIB
$122.7
5.6%
Ontario Teacher’s Pension Board
$108.5
15.1%
bcIMC
$85.0
13.9%
AIMCo
$70.0
9.7%
OMERS
$51.5
12.5%
PSP Investments
$38.9
11.7%
HOOPP
$30.0
10.3%
resource wealth, future capital contributions to AIMCo are likely to be significant. There is a clear trend by Canadian investors towards increasing investment abroad to satisfy their direct property requirements and to generate higher risk adjusted returns. According to Statistics Canada, the share of overall foreign asset holdings by trusteed pension funds has increased 9.3% since 2000 and 4.5% since 2005. Much of this spending is taking place in Europe and we are beginning to see interest in emerging markets and Asia. An important driver has been the government’s 2005 amendment to foreign content rules, which eliminated the 30% cap on foreign asset holdings. In addition, the maturity and relative size of the property market in Canada, combined with increased interest from both domestic and foreign investors, has resulted in an increasingly competitive landscape with a limited supply of available institutional grade investment property within Canada’s major markets. The growth in Canadian offshore investment activity is not unlike the experience of Australia, where a similar lack of new stock and investment opportunities, combined with a significant growth in superannuation fund capital and a desire to spread the risk profile, has resulted in increased interest in foreign markets. One unique factor of the Canadian market is the consolidation of core assets by the largest domestic investors, which includes the aforementioned pension plans and their subsidiaries, but also includes life companies, such as Sun Life, Manulife and GWL (Canada Life in Europe), and Canadian listed property companies and REITs, such as Brookfield and Homburg. In the context of prime
Real estate subsidiaries
SITQ, Ivanhoe Cambridge, Cadim, Bentall Capital, CW Capital Cadillac Fairview
Oxford Properties
office properties, a significant proportion of the largest assets in Canada are held by/ managed by the “big 5” – Cadillac Fairview, Oxford Properties, GWL Realty Advisors, Brookfield Properties and Bentall Capital. With the exception of Brookfield, a publicly listed company, all of these investors deal with retirement-related assets to some degree or another. As these investors already hold significant concentrations of assets in Canada’s major markets, they must look to leading cities in other countries to diversify and expand. Other factors are also at work; conservative lending on behalf of Canada’s financial institutions has resulted in more constrained development and limited the ability for funds to grow their domestic portfolios. Speculative development has been far more limited in comparison to build-to-suit activity. Not surprisingly, a significant share of Canadian direct foreign investment into property has historically been into the United States, which accounts for slightly more than half of the nearly $22 billion directly invested around the globe by Canadian investors since 2003. While economic ties between the two nations continue to weaken, as a growing share of Canadian exports go elsewhere, each remains the other’s largest trading partner and, as such, their economies share a degree of correlation. So investing in the large US market, while appealing for many reasons, limits Canadian investors’ ability to achieve portfolio diversification gains, hence the appeal of European and Asian investment. In fact, since 2003 Canadian investors have acquired more property in Greater London than in any other metropolitan area market
Source: Statistics Canada
Canadian outflows to foreign real estate, 2003–2008*
outside of their borders, acquiring more than twice as much as they have in New York. And while London remains attractive, as evidenced by Ontario Teachers’ recent 50% stake (€ 170 million) in Thomas More Square in London, they are moving further afield, as seen in Ivanhoe Cambridge’s acquisition of a shopping centre in Moscow. Similarly, although fully half of all outbound investments have been in the office sector, Canadians are actively pursuing opportunities across all sectors. Investing directly from across an ocean, however, presents logistical challenges. So while the major Canadian investors continue to make significant direct investments in Europe and Asia, they are also making significant fund-level investments. In 2007 alone, major Canadian investors made significant fund commitments to entities investing specifically in Turkey, China, Brazil, Mexico, as well as into Pan-European and Pan-Asian funds. CPPIB alone has recently opened offices in both London and Hong Kong, having acquired more than $1 billion in Asia via funds and joint ventures, and have completed a wide range of similar fund investments in Europe. CPPIB recently invested $307 million in Henderson UK Shopping Centre fund and $243 million in the Westfield UK Shopping Centre Fund.
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215 Slater Street, Ottawa
Investment into Canada Direct investment in Canadian real estate by foreign investors has been more muted, but this is in keeping with the size of the Canadian market. With a population of just over 33 million, Canada is significantly smaller in terms of population than the UK, France, Germany, Italy and Spain, and ranks ninth globally in terms of GDP, just behind Spain and just ahead of Brazil, Russia and India. However, in a market where there are no barriers to foreign ownership of property assets Canada is one of the easiest markets for non-domestic investors to access. The Canadian market typically sees an average of $20-$25 billion in significant investment transactions per year across the four major sectors (office, industrial, retail and multifamily). According to Real Capital Analytics, cross border investment into Canada represented 23% of total real estate investment volume in 2007. To date, most foreign investment has been in the major markets of Toronto, Vancouver, Calgary and Montreal. Combined, these four markets account for roughly three- quarters of a national office inventory that exceeds 400 million sf. Toronto is the largest market, more than twice as large as the next largest, Montreal. Most new office development activity, however, is in the nation’s energy capital, Calgary; with more than 8.5 million sf under development (a mix of speculative and build to suit developments) it accounts for just under half (44%) the Canadian office construction pipeline. Not surprisingly, acquisitions on behalf of foreign investors have been weighted towards the office sector. In the three markets of Toronto, Calgary and Vancouver, office investment represents on average 71% of foreign investment allocation. In contrast to its southern neighbors in the Americas, where double-digit vacancy rates are the norm in many markets, Canada’s major office markets have seen vacancy tighten, in some cases to near record lows, and continue to offer significant risk premiums, as measured by income yields which remain 200+ bps above comparable Canadian treasury yields.
development investment options. Beyond oilbooming Calgary, Vancouver is gearing up to host the 2010 Winter Olympics, and Toronto, one of North America’s fastest growing economic regions, is home to over 5 million people and generates more than 20% of the country’s GDP.
Conclusions Canada has long enjoyed a significant trade surplus, exporting its finished goods and raw commodities around the world. With its abundant natural resources and its move towards increasingly self-sustaining, fully-funded pension funds, Canada has become an exporter of real estate capital as well, a trend which shows no signs of abating.
Greater market size, Sf.
Overall vacancy
CBD class A vacancy
Under construction, Sf.
Toronto
124,008,377
6.4%
4.1%
6,737,223
Montreal
77,752,643
8.8%
7.4%
430,000
Calgary
51,540,881
5.0%
2.4%
8,543,075
Vancouver
44,803,237
5.7%
2.1%
1,310,407
Although the most significant investments are expected to continue to come from a small group of extremely large investors, Canada’s mid-size pension funds, REITs and Life Companies may be next. No stranger to collaboration, as evidenced by joint venture acquisition of assets and cross-ownership of companies between major Canadian pension plans, some of these smaller entities may team up to make core investments in Western Europe and more opportunistic entries into Eastern Europe, Asia and South America.
Govt of Canada 10 year benchmark bond yield vs. class A office market overall cap rate (OCR) Q1/2000–Q2/2008
At the same time the Canadian market itself offers a potential attractive alternative to foreign investors. While 2008 looks to be a weak year for job and GDP growth within Canada, real estate fundamentals remain sound, with market total returns standing at 14.2% for the 12 months ending June 2008. Vacancy remains in the single digits and healthy yields are expected to continue to attract nonCanadian investors into the nation’s largest markets.
Given this, non-Canadian investors looking for strong income returns in core product would do well to consider Canada’s four major markets, which also offer interesting
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Market focus: a look at markets currently in investors’ sights Helsinki, industrial The Nordic countries have been some of Europe’s strongest performing economies in recent years, and as a group look set to withstand the current global downturn better than their larger neighbours. Strong employment growth, rising real incomes and healthy consumer spending has helped to sustain occupier fundamentals, which, together with the high degree of transparency in the market, makes the region a relatively attractive prospect for international investors. Finland has been the region’s strongest performer so far in 2008, to some extent protected from the slowing global economy by its proximity to its largest trading partner – Russia. The country also boasts excellent trade links with the Baltic region, and, with sea traffic between Finland and Tallinn growing, the port of Helsinki is emerging as a hot tip for investors seeking logistics assets with strong growth potential. Many operators, who hitherto entered Russia via Baltic waters (which are not ice-free in winter), are now opting to enter via Finland. In line with strong growth in cargo volumes over the past five years (which has correlated with a rapid increase in capital values), Helsinki is undergoing a major transformation, with all cargo activities being transferred to the new Vuosaari Harbour. The new port will be operational from November this year and will offer excellent transport connections for logistics operators (the new port is located some 14kms from downtown Helsinki and the project includes the extension of Ring Road III to the new seaport, as well as a new railway line for transporting goods in and out of the harbour). The development also comprises a 75-hectare business park. Combined, Vuosaari harbour and the new business area are expected to generate approximately 3,500 jobs. This will fuel demand for logistics space as the new harbour replaces some of the functions of the North and West harbours. Initially, however, rental growth may be limited as new supply is absorbed into the market. The new harbour will play a key role in raising Helsinki’s profile as an international logistics market, drawing international developers to a
country which has historically been dominated by either local developers or developers from neighbouring Nordic countries. Having moved out to 7.25% at the end of Q2 2008, prime yields in Helsinki are expected to stabilise going forward and the sector currently offers some of the highest returns in Europe. This, combined with a robust outlook for rental growth and a stable economy, should provide foreign investors with adequate security and income prospects.
Bucharest, industrial In the past, Romania’s industrial market has been held back by a poor economy, a declining population and limited infrastructure, which has restrained both the investment and occupier markets. However, anticipation of and accession to the EU has changed this, dramatically improving the country’s economy and business environment. The early part of 2008 has seen the Romanian economy continue to expand rapidly as it experiences an ongoing construction and investment boom, supported by significant foreign investment. However, the risks of sharp a slowdown have increased due to the recent surge in inflation, weaker demand from the euro area and the tightening of external financing conditions amidst the credit crunch (especially relevant given the country’s heavy dependence on foreign debt). Bucharest dominates the country’s industrial and logistics market due to its strategic location and better quality infrastructure – the city lies 225km from the port of Constanta, 850 km from Budapest, and at the junction of two pan-European corridors. Although the logistics sector is still hampered by poor infrastructure, the situation is rapidly improving and there are a number of large-scale infrastructure improvements either underway or recently completed, such as the new A2 motorway between Constanta and Bucharest. All are part of a huge €12.8 billion strategy to improve the country’s motorway network, thus transforming Romania’s logistics landscape and helping to attract more Foreign Direct Investment (FDI). Looking at occupier activity, the market is currently characterised by strong demand for
modern warehouse space and is driven primarily by large multi-national companies entering the market or by those relocating from unsuitable old facilities. The retail sector plays an increasingly important role in the logistics market and the arrival of large multinationals will continue to boost demand for space. As an example, in 2007, the French supermarket chain Carrefour leased 45,000 sq m of space in Cefin Logistics Park in Bucharest. Although new supply of modern logistics space is scarce in Bucharest, development is increasing, with stock reaching 500,000 sq m at the end of 2007. Most new developments are located along the A1 highway to the west of the city. DTZ expects yields to move out in the next few months, holding stable thereafter. At 8.25%, prime yields in Bucharest are amongst the highest in Europe, and, despite the recent increased financial risk in Romania, logistics investments in Bucharest seem to offer an adequate risk adjusted return in a sector and economy with good near term growth prospects.
Istanbul, offices Further south, the Turkish real estate market is thriving; having achieved impressive returns in all sectors over the past few years. This strong performance has been supported by a sustained economic expansion, driven by strong growth in consumer spending and supported by the gradual lowering of inflation, which has been a long-standing problem in Turkey. The economic outlook is for continued growth, but at a slower pace than in recent years. As in most other countries, economic prospects in the near term have been dampened by the global credit crunch, the recent spike in inflation and slowing trading partner growth. Turkey is more exposed than most to these shocks, given the private sector’s significant reliance on external financing and the authorities’ ability to manage inflation will be an important factor in maintaining investor’s confidence. Turkey has a reputation as a high risk location for the real estate investor, reflecting a history of market volatility, political instability and the
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complexities inherent in the Turkish legal system. Amidst the current environment of heightened inflation and financial risk, investors will be looking for assurance from the authorities that they can provide macroeconomic and political stability over the long term.
European ofďŹ ce markets outlook
European industrial markets outlook
Investors who have ventured into the Turkish market have enjoyed impressive returns of late, with Istanbul’s CBD (European side) office market a particularly strong performer, experiencing rapid rental growth of up to 45% during 2007. This was driven by strong occupier demand and a lack of available space for new development opportunities, with vacancy rates dropping well below the EU average at less than 5%. However, lack of available stock remains a constraint on investment opportunities. Yields are expected to remain stable in the medium term after the recent years of compression. Although expected to slow, forecast rental growth in coming years is nevertheless anticipated to be the highest of any office market in Europe, offering those investors willing to take on the associated risks the potential for above average returns.
London City offices Given its heavy exposure to the financial sector, the London City occupier market has been hit hard by the credit crunch, with rental values under pressure against a background of weakening occupier demand and a substantial supply pipeline (approximately 6m sq ft. over the next 24 months, notwithstanding postponement and cancellation of schemes as a result of financing difficulties or downgraded expectations of occupier demand). Against this background prime rents are expected to fall by about 25% over the next two years. Investment yields have moved out by c. 175bps since their trough in mid 2007, reflected in a sharp decline in returns, and this repricing has further to go before the market bottoms out. Recent developments in the wider financial system, including the failure of Lehman and the takeover of HBoS have, at best, only increased uncertainty as to when this will occur. However, the relatively rapid price adjustment which has already taken place is beginning to make prime London assets look much better value in the context of the wider European investment market, particularly in an environment characterised by a general flight to quality. Equity based overseas investors, notably German OEFs, Middle East capital and Sovereign Wealth Funds have become more active in the market in recent months, and more are likely to follow once the market is convinced the current correction is drawing to a close.
Total returns, average 2009–2012
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Notable deals Property
Buyer
Seller
Location
Price
Date
1. Vasakronan portfolio: 172 office and retail properties
AP Fastigheter
Vasakronan (owned by the Swedish state)
Sweden
€4,351 million
Q2 2008
2. Steen & Strøm portfolio, shopping centres
ABP Pension Fund and Klépierre
Steen & Strøm (Canica)
Sweden, Norway, Denmark
€2,700 million
Q3 2008
3. Corio Portfolio, office, industrial
White Estate Investments
Netherlands
€650 million
Q2 2008
British Land
UK, London
€505 million
Q2 2008
4. Willis office building
St Martins
Corio
5. Portfolio of designer outlets
Henderson Global Investors
Consortium of investors, Morley, AXA and more
UK
€455 million
Q3 2008
6. ‘La Maquinista’ and ‘Habaneras’ shopping centres
Unibail-Rodamco
Metrovacesa
Spain, Barcelona, Torrevieja
€434 million
Q3 2008
7. Bloc II, offices
AXA Belgium
Eurostation SA
Belgium, Brussels
Above €250 million
Q2 2008
1. The Swedish state has sold the largest property company in Sweden to AP Fastigheter, a Swedish property vehicle controlled by the AP-funds, who manage the capital from the Swedish pension system. The portfolio comprises 172 properties (c. 75% office). The deal was financed through shareholder equity and a consortium of four Nordics Banks; Nordea, SEB, Danske Bank and Svenska Handelsbanken AB. The Swedish government intends to pay down national debt with the proceeds from the sale. With the purchase of Vasakronan, the total value of the property portfolio in AP Fastigheter is estimated to be c. € 9 billion, with a loan to value ratio of 54%. 2. The Steen & Strøm shopping centre portfolio was put up for sale towards the end of last year, at which point the expected price tag was estimated to be c. € 3.2 billion, €500 million more than Dutch ABP Pension Fund and French Klépierre are expected to pay. The portfolio holds well-known prime shopping centres across Scandinavia with a total lettable area of c. 780,000 Sqm, of which more than 96% is let. ABP, the property management arm of BNP Paribas and Klépierre, the third largest listed property company in France, expect a 6.2% yield on the portfolio. At the moment the Steen and Strøm has a noteworthy development pipeline, of which 6 new shopping centres are under construction. The transaction is yet to be finalised and is subject to routine regulatory approvals.
3. Listed Dutch company Corio has entered into a € 650 million deal with a consortium of investors led by White Estate Investments. Corio disposed of their Dutch office and industrial portfolio, accounting for c. 17% of its total property portfolio. The lack of credit availability in the financial markets effectively diminishes the potential number of purchasers for large scale properties and portfolios and Corio is splitting up their portfolio in order to maximize the premium on their assets. White Estate Investments has purchased this portfolio slightly (1.5%) below the end 2007 valuation and the yield is estimated to be c. 7.25%. 4. Middle-Eastern investors are stepping up their investments in UK, targeting Central London offices. St. Martins, the investment arm of the Kuwait Investment Authority, completed one of the largest office deals in London in 2008 with the purchase of the Willis office building from British Land. With the building currently fully let, the deal reflects a yield of 5.7%. St. Martins are thought to be considering other real estate opportunities in London.
swift decline in capital values and repricing of risk in the UK market. 6. Financing pressures on Spanish listed property company Metrovacesa has forced it to sell off assets to restore liquidity. Europe’s biggest property company Franco-Dutch Unibail-Rodamco found themselves in a favourable position to strike a good deal on these two prime shopping centres with opportunities for further expansion of the centres. Unibail-Rodamco’s secured these prime assets at a lower price than the competition due to their ability to close the deal quickly. It is projected that Metrovacesa lost € 7.2 million on the deal which reflected a yield of c. 6%. 7. In Belgium, DTZ advised Eurostation, subsidiary of SNCB/NMBS , the National Belgian railway company, on the disposal of 66,000 m2 of office buildings to AXA, the country’s largest single property transaction in 2008.
5. Three designer retail malls have been purchased by Henderson Global Investors as a part of their UK Outlet Mall Fund. Henderson raised c. € 225 million in equity for the 10-year closed-ended fund. The remaining debt to finance the largest retail deal so far in 2008 came from Bayerische Landesbank. The tenants are of high quality with multiple representations across the portfolio. The high yield, estimated to be just above 7%, clearly indicates the
Eurostation Bloc 2
Contacts John Slade +44 (0)20 7757 6685 Paul Abrey +44 (0)20 7643 6115 Paul Sanderson +44 (0)20 7757 6880
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DTZ employs over 12,500 people in 150 cities operating in 45 countries. © DTZ Research October 2008 This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ Debenham Tie Leung can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited.
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