Euro trillions
Europe's biggest institutional property investors gathered for the annual Expo Real property trade fair in Munich in last week, and Investors Chronicle was there to assess the mood.
There's certainly increased enthusiasm for owning property assets, but this is tempered by the structural problems caused by the crash. In short, indebtedness is the root of all evil.
Total outstanding real estate debt in Europe totals nearly E1 trillion, according to research released last week from investment manager Invesco Real Estate. Doris Pittlinger, its head of fund management, estimates that E65bn (5 per cent of total loans) are in trouble, or have breached lending covenants. But other prominent European fund managers think that a figure of E260bn (20 per cent of the total) is more likely.
The result? An unnaturally illiquid market. Banks don't want property assets cluttering up their balance sheets, but many loans are still worth more than the properties they are secured on. Where interest payments are being covered, banks are left with little choice but to 'extend and pretend'. To sell assets at a loss would have dire consequences for other property assets on their books.
Nevertheless, more imaginative solutions are being found. Increasingly, banks are forming joint ventures (often with listed property companies, see next page) who can bring both equity and expertise to the table.
Europe's listed property companies have recapitalised, with billions of euros worth of rights issues, placings and bond issues showing they can raise cash even if the banks are unwilling to lend. Furthermore, institutional investors are seeing the listed sector as a better way to play Europe's property markets than buying property assets directly.
Reit resurgence?
Fund managers fear an incoming wave of regulation will make owning direct property assets more troublesome. As well as the Basel III banking regulations, European Solvency II legislation means insurance companies will have to hold greater equity reserves to bolster their property investments. This adds up to a less effective use of their capital, but could have the knock-on effect of boosting institutional investment in real estate equities.
"Will the increasing regulatory burden increase the attractiveness of Reits [real estate investment trusts]?" asks Joe Valente, head of real estate investment strategy at German insurance giant Allianz. "It should do. But the problem is that the European-listed sector is woefully small compared with US counterparts."
Perhaps this strategy offers greater scope for private investors. Regardless, this is just part of a wider step-change in the way Europe's biggest institutions are changing their perceptions of property. Property has evolved from being seen as a leveraged, growth investment to an income-producing safe haven.
"Is now a good time to buy?" asks Mr Valente. "Unquestionably, yes. But where the hell do we find value? We've gone from an end-of-the-world scenario two years ago back to 5 per cent real estate yields. That seems expensive, but bond yields are barely 2 per cent. Next year will be tough, and values will probably fall, but property's a cyclical business and we have a medium- to long-term view."
Opinion at Expo Real was that the recent spurt in property values will not be repeated, regardless of whether quantitative easing makes a comeback, and the outlook for rental growth is also weak. But there are certain markets that have the potential to outperform.
Mapping value
"The bounce is almost over for most markets," says Dr Angus McIntosh, head of research at European property consultancy King Sturge. "The outlook suggests that only a few markets such as central London and Paris, plus some Swiss cities and Moscow, are likely to see rents move up. In other markets rents will be level, or perhaps fall slightly."
The German office market remains a popular theme for investors, who are encouraged by the country's strong economic growth, and the same sentiment applies to commercial property in Poland, which was the market creating the biggest buzz at Expo Real.
Further into central and eastern Europe, property research houses note that most of the countries ending in an 'a' (Russia, Romania, Bulgaria, etc) have yet to witness any recovery in property values. For optimists, this could mean greater yield shift is possible in the future, but the risk averse may conclude that these high-risk markets are now fairly priced.
Scandinavian real estate is a very small slice of Europe's property market by value, but it is viewed as a safe haven by many investors. And then there's the 'unloved' markets, particularly Spain, where unemployment is over 20 per cent. However, uncertainty has lead to sharp corrections in property values, and braver investors are now sizing up the investment potential.