On the ground: perceptions vs. reality in Europe

August 25, 2014 admin
An interview with VIP – Europe’s advisory board member Roger Barris, partner and chairman, Peakside Capital Advisors, Ltd.

An interview with VIP – Europe’s advisory board member Roger Barris, partner and chairman, Peakside Capital Advisors, Ltd.

Roger Barris is a founding partner of Peakside Capital. He was formerly a managing director and head of real estate principal investments at Bank of America Merrill Lynch, which he joined in 2005. From 1997 to when he joined BofAML, he held senior-level positions at Starwood Capital (where he was the partner in charge of Europe) and Deutsche Bank AG (where he was the managing director responsible for the European activities of the real estate opportunities group). Prior to these positions, he held various positions in the mortgage securities department of the Goldman Sachs Group in New York City and London.

Save the date to join us at our fourth annual Visions, Insights & Perspectives – Europe conference, which takes place February 24–25, 2015 at the Hotel President Wilson in Geneva, Switzerland. This event is built for the European real estate investor community and is an excellent forum for international investors to attend to gain an on-the-ground perspective on what’s really happening in Europe.

With that in mind, I recently posed a few questions to Roger:

Europe is attracting a large amount of capital today. As highlighted in Institutional Real Estate, Inc.’s FundTracker publication, 2014 fundraising is off to a great start. Europe-focused funds accounted for 50 percent of first quarter’s $22 billion total. Much of this capital is flowing from Asia and the United States into Europe. What are the main drivers of those flows, and how long do you see it continuing?

I think that you have to look at this by segment. Much of the Asian capital is coming from sovereign wealth funds or from very large institutional investors, such as insurance companies and pension funds. This money is targeting primarily core investments in large, liquid markets, such as London and Paris, and now spreading to Germany and even Poland. This money is primarily seeking diversification benefits, including through “safe haven” status, and is sometimes also looking for higher yields than are available in domestic markets.

The U.S. money, conversely, is largely opportunistic. This money is being driven by both “pull” and “push” factors. The pull is the evident recovery in the European economies and the opportunity to participate in this, particularly by focusing on “distressed” opportunities. The “push” is the perception that the U.S. market, which moved earlier and more aggressively to clean up its problems, no longer offers the same type of early-cycle opportunities.

What opportunities and dislocations are these flows creating in European markets?

The demand for core assets, which is very strong from both international and domestic investors, is creating an opportunity to “manufacture” core from assets that currently suffer from poor physical condition or vacancy. We expect this demand to remain strong for a number of years, reflecting an economic environment of weak growth and very low interest rates, combined with a fear that central bank monetary initiatives might overshoot and create significant inflation. In this environment, few assets look as attractive as core real estate, which offers a yield much higher than most fixed income alternatives and also considerable inflation protection.

Are distressed opportunities available today in Europe?

There are certainly a lot of “motivated sellers” in the European markets. This comes from the banking sector, which still controls, directly or indirectly, plenty of overleveraged real estate. The previous approach with these assets was “extend and pretend” or “delay and pray,” with the tacit approval of local regulators, but this cozy practice has recently been broken by the European Central Bank and its “Asset Quality Review.” The ECB has made very clear that the AQR will be tough, and banks are finally being forced to mark assets to clearing levels, which means that they can be sold without further capital hits. It also helps that ultra-low interest rates and a strong equity market have made it possible for banks to rebuild capital.

The second group of motivated sellers is cross-border investors from the pre-Lehman bubble days, many of them operating through funds that can no longer draw capital for necessary capex or that are approaching a maturity date. These investors frequently never understood the markets into which they ventured and are now looking to dispose of these noncore investments. They were often supported by their domestic banks, which are bringing further pressure to bear since they, too, want to exit noncore markets.

So the supply side of distressed sellers is very strong. The problem is that the demand side for the large deals is even stronger. Even a motivated seller will get the better side of the bargain if he is able to generate competition among many highly motivated buyers. This is exactly what is happening in Europe for any large transaction. The reality is that, even in peripheral markets, the level of competition for large deals is enormous — we understand that, when the Spanish bad bank SAREB came to London to present its disposal program, 250 investors signed up to meet them!

What risks do you think investors should focus on when evaluating Europe and why?

The biggest risk is macroeconomic, particularly in the peripheral economies but also in some core markets, such as France. The reality is that pricing in these markets has gotten way ahead of economic and real estate fundamentals, and will only make sense if these economies recovery strongly and quickly. Although anything is possible, we continue to see huge headwinds for these economies in the form of heavy debt loads and overly rigid and uncompetitive economies. One of the reasons why we focus one Germany, Poland and the Czech Republic is that they don’t face these macroeconomic obstacles. We are confident that if we succeed in “fixing” a building in these countries, all of our good work at the “micro” level will not be swamped by negative — or even insufficiently positive — developments at the “macro” level.

What are some of the ways those risks can be managed?

Unfortunately, macro risks cannot be “managed”; they can only be avoided.

Where do you see opportunities, and why?

We think that there are very interesting opportunities to “buy, fix and sell” buildings at the micro level. We think that it is important to “buy well”, focusing on motivated sellers in situations of limited or no competition; this occurs most often with mid-market deals that are below the amount of money that the large funds need to invest. It is then important to add value through capital expenditure, repositioning and aggressive leasing. The assets that we typically buy are good quality real estate that has suffered from overleveraged, weak ownership. This is the distressed opportunity that we think is interesting in Europe, and it grows every day as more and more buildings become needy of capital and expertise.

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JohnHunt91x119John Hunt is conference program manager with Institutional Real Estate, Inc.

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