Tuesday, July 16, 2013

Italy to Spain Beckon as Yields Beat Germany: Real Estate

Originally Appeared in Bloomberg News


Europe’s biggest real estate managers are making their first investments in southern Europe since the financial crisis as low prices and diminishing risk make commercial properties more attractive.

Axa Real Estate Investment Managers, the largest European property fund manager, bought Barcelona office buildings from the Catalan government for 172 million euros ($224 million) last month, only its second purchase in the country in five years. When the unit of Europe’s second-largest insurer considered buying the same properties two years ago, it rejected the idea.

“There was too much uncertainty in the market at the time,” said Anne Kavanagh, the Paris-based insurer’s head of global asset management. “There’s an indication now that we’re at or near the bottom, even though there might be more volatility ahead.”

Insurance companies such as Germany’s Allianz SE (ALV), private-equity firms and sovereign-wealth funds are seeking deals in Spain and Italy as the economic prospects for the countries improve and the likelihood of a euro-currency breakup recedes. Returns in the commercial hubs of Madrid and Milan have become more attractive compared with other European cities after a slide in investment in both countries last year boosted yields.

Axa Real Estate, which has 45 billion euros of assets under management, agreed to buy an office park in Milan last month, its first commercial property transaction in Italy since 2008. Before the Barcelona acquisition, the French insurer’s only transaction in Spain in the past five years was the purchase of a chain of gasoline stations for 55 million euros in 2011.

Rome, Milan
Allianz, Europe’s largest insurer, in June bought a stake in two buildings in Rome and Milan, its first Italian deals in five years. Georg Allendorf, head of German property at Deutsche Bank Asset & Wealth Management, said he’s considering buying real estate in southern Europe for the first time since 2010.

Yields for prime offices were about 6.25 percent in Madrid in the first quarter, up from 5.75 percent a year ago, and in Milan they were unchanged at 6 percent. That compares with about 4.9 percent in Frankfurt and 4.75 percent in London, according to data compiled by CBRE Group Inc. The yield is the annual income that a property generates as a proportion of its purchase price. Yields tend to rise when values fall.

“There are many international investors who are coming back, or coming into the market for the first time,” said Mauro Montagner, head of Allianz Real Estate in Italy, which plans to invest 500 million euros over the next several years. “They realize it’s no longer like trying to catch a falling knife.”

Low Point
The renewed interest comes after commercial real estate investment in both countries tumbled in 2012 to the lowest level since at least 2001, according to research by DTZ. Investment dropped by almost 70 percent to 1.2 billion euros in Italy and by more than 50 percent to 2.3 billion euros in Spain.

Investment in both countries will begin to recover this year and return to pre-crisis levels as early as 2014, said Magali Marton, head of continental European research at DTZ. The money spent on commercial properties could amount to 3.5 billion euros in Italy and 2.5 billion euros in Spain in 2013, she said.

“The market is more dynamic than it seems from the outside,” said Allianz’s Montagner. In one case, Allianz is competing with eight other investors for an Italian property that probably wouldn’t have attracted any interest a year ago, he said.

Euro’s Survival
Buyers are drawn by the prospect of an improved economic outlook in Spain and Italy and growing confidence that the euro will survive, said Peter Damesick, chairman of Europe, Middle East and Africa research at broker CBRE Group Inc. in London.

“It’s certainly a shift compared to 12 or 18 months ago, when concerns about the euro zone and its integrity were running at a very high level,” he said.

The Spanish economy is set to grow by 0.9 percent in 2014 after contracting two years in a row, according to the European Commission. Italy will expand by about 0.7 percent after also shrinking for two years. Concern that the euro would break up began to abate in September, when ECB President Mario Draghi pledged unlimited bond buying to prop up the 17-nation currency.

Since then, the difference between the extra yield investors demand to hold Italian government bonds compared with German debt has narrowed by about 110 basis points, according to data compiled by Bloomberg. The difference, or spread, between Spanish and German debt has narrowed by 180 basis points. That shows that investors see diminishing risk in those countries.

The ECB expects to keep interest rates low for an “extended” period, Draghi said on July 4. The central bank that day left its main refinancing rate at 0.5 percent.

Risk Appetite
While countries such as Germany and the U.K. attract the bulk of investments because of their reputations as havens, buyers are increasingly willing to take on more risk to earn higher returns.
“We’re starting to see a rotation from defensive to riskier investment,” Kavanagh said.

The appeal of Italy, Europe’s fourth-largest economy, lies in robust consumer spending and increased political stability after the appointment of Enrico Letta as prime minister in April ended months of political gridlock, DTZ’s Marton said.

“The political class has demonstrated its capacity to manage the country and take the right decision to reduce public debt,” she said.

Italy’s real estate market is more promising than Spain’s because of the country’s strong industrial sector and because it didn’t experience the construction boom that has burdened Spain with an oversupply of buildings, she said.

Bad Bank
While the economic outlook in Spain is worse, with unemployment at 27 percent, the real estate market may benefit from discounted properties sold by Sareb, the bank set up by the government last year to acquire 90 billion euros of soured real estate assets from rescued lenders. Sareb is preparing to sell 1.5 billion euros of assets this year.

Apollo Global Management LLC (APO), a New York-based private-equity firm, plans to invest 1 billion euros to buy loans from banks in Spain as well as from Sareb, a person with knowledge of the matter said. The person asked not to identified because the company hasn’t announced the plan to the public. Apollo declined to comment.

Spain’s bank rescue fund, known as FROB, owns about 45 percent of Sareb, while other shareholders include 14 Spanish banks.

Lowered Expectations
Owners of Spanish property are facing financial and regulatory pressure to sell after holding assets for years to avoid realizing losses. Others have lowered their expectations as the country’s economic woes drag on.
The International Monetary Fund yesterday called on Sareb to use more conservative assumptions for house prices in its business plan “as these are still falling sharply and further correction is likely.”

“There is more reality in European pricing than there was 12 months ago,” Axa Real Estate’s Kavanagh said. “When owners start marketing an asset and getting the bids, they realize where the market is. That process can take a while,” he said.

Axa Real Estate will achieve a gross initial yield of about 9.5 percent with its Spanish office purchase, according to two people with knowledge of the transaction. A year ago, that deal would have probably yielded 8.45 percent, according to one of the people. They asked not to be identified because the information is private. The yield is the income return on an investment. Yields normally fall when prices rise.

Some companies are setting up new businesses ahead of an anticipated increase in transactions. NAI Global, a real estate adviser, added its first offices in Italy and Spain this year.

‘Good Timing’
“It’s a very good time to expand into those markets,” said Paul Danks, NAI Global’s managing director for Europe. “The majority of the big-name investors have always been in the market, but clearly over the last few years they haven’t been active.”

Some of the transactions are likely to come from banks that took over buildings or loans from troubled creditors and now face pressure to reduce their real estate holdings to comply with new rules. These include Basel III, the banking regulations that come into effect in 2019.

CR Investment Management, a Berlin-based firm that manages and restructures troubled properties and loans, opened an office in Madrid in July.

“As loans secured on Spanish assets start to trade, many of the capital sources we work with will require an operating partner to assist them with underwriting and managing the loans they are looking to buy,” said Richard Fine, head of CR’s international operations in London.

Different Targets
Investors are targeting deals for hotels, homes, offices and warehouses. Insurers such as Axa and Allianz are focused on modern, high-occupancy office buildings on busy streets. Private-equity firms such as Cerberus Capital Management and Fortress Investment Group LLC (FIG) are targeting distressed homes held by Spain’s Sareb, a person familiar with the information said in February.

Qatar’s sovereign-wealth fund in May agreed to buy a 40 percent stake in Milan’s newly built Porta Nuova business district. While the purchase price wasn’t disclosed, the project is valued at about 2 billion euros, the Qatari fund and developer Hines Italia SGR said in a statement in May. Qatar in June also bought the W Hotel in Barcelona for about 200 million euros, according to Property Investor Europe.

In February, Luxembourg-based asset manager GWM Group bought Italian logistics properties valued at about 220 million euros after the owner had trouble repaying loans from Deutsche Bank AG (DBK) and M&G Investments, according to a February statement from GWM.

In Spain, the past year has also seen the arrival of investments from wealthy families in Latin American countries such as Mexico, Chile and Venezuela, Damesick said. As deals close, more investors will be comfortable entering the markets, he said.

“One of the issues that held the market back in the past couple of years was a circular process of low liquidity creating uncertainty about pricing in the market,” he said. “When things go in the other direction, it gives more investors an incentive to move in.”


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