Foreign capital targeting real estate in Europe has had a number of compelling incentives to invest in Spain in recent years, and the retail asset class in particular has stood to benefit particularly from expectations of growth in consumer confidence and spending, among other factors.
Since 2006, foreign capital has invested 16.8 billion euros in Spain. In the early part of the Global Financial Crisis (GFC) the profile of much of this capital was opportunistic, seeking to take advantage of a distressed market whose finance had all but disappeared. The global view of Europe however is changing. As many European countries continue to show signs of recovery, less capital is being allocated to Opportunistic funds and investors are become more risk averse. Quality prime real estate however is not easily created and in Spain, many if not most are already in the hands of long-term institutional holders. Investors are therefore increasingly looking to regional locations and “Core Plus” assets in addition to the development pipeline as it begins to slowly deliver product, some of which has been on hold since pre-2008.
In the context of a strong competition and scarcity of product, the global amount of new equity that funds are currently seeking to raise has declined, with EMEA reporting the sharpest falls. This is not to say that fund raising has stopped altogether. In 2016 Blackstone registered a €5.5bn close on its latest European fund, and is targeting a similar amount for a second Pan Asia fund, having deployed 70% of capital in its first fund.
Nevertheless, many managers are tasked with deploying existing capital before raising fresh funds, a slow and frustrating process as vendors in turn see little opportunity for reinvesting at suitable returns once they have released their stock. Inventiveness and creativity are therefore key requisites for fund managers in 2017 as supply will remain limited and managers will consider options such as JV’s, club deals leaving the asset manager in place, forward funding etc., and the ability to invest in “secondary good” – core plus assets with pro-active business plans.
Diversified funds continue to dominate, but there is a general trend towards targeting single property types requiring more specialist asset management, or where collective investment allows investors to target assets with larger lot sizes, such as shopping centres. In countries with remaining room for growth, this has the compound potential for capitalizing on sales and rental growth.
In the European region, Spain still offers investors a higher return for a lower risk profile compared to much of southern Europe. The delayed formation of government proved to show that the autonomous regions were sufficiently strong to bridge the gap and national populist sentiment seems to be receding. In the wake of Brexit, Spain has been a relative European success story and the efforts to implement effective austerity measures have been paid back with leniency. The 2016 deficit target of 2.8% of GDP would have been missed, had the European Commission not moved the target up to 4.6%. All of this sends a powerful message to foreign investors, who made up more than half of all real estate investments in Spain in 2016.
The availability of debt has further encouraged foreign investors, but often within narrow parameters. Lender’s preference for quality/prime product is of most benefit to large institutional funds with high availability of equity.
Vendors of Secondary or lower quality assets – those most in need of capital injection and improving/”repositioning” redevelopment – are not all waiting for the finance markets to return to higher risk lending. Although finance may help to bring returns into line with investor targets, Vendors often resist offers that are subject to finance. While this is understandable - the demand exists to justify such an approach - the perceived risk contributes to the mismatch of pricing expectations between market and sellers, particularly for unconventional transactions such as sale & leasebacks, secondary schemes needing to be repositioned, etc.
Increasingly, Vendors are using equity to improve, expand and reposition assets prior to sale and increase their appeal to purchasers. However, realizing the potential in real estate carries its own risks, as the returns are eaten away and pricing moves too far out for Value-Add capital, while the historic performance offers no comfort for Core Capital. This Core-Plus/Value-Add territory is a growing area driven by a lack of product and a focus on secondary-good assets.
The high equity macro environment and the imbalance in Spain between supply and demand are driving the return of development. “Build-to-core” strategies targeted at establishing modern assets that over the long term can outperform older, existing buildings in competing for tenants and achieving higher occupancy rates and better rents, present an attractive option for investors.
The retail class however is a more complex proposition, investors cannot simply build themselves into the market. Instead, investors must consider how to improve existing shopping centres and, to a certain degree, follow the retailers as they expand into dominant schemes in secondary towns - as long as there is a strong catchment area and a convincing sales story. Investors who are astute enough to understand the ingredients of a successful retail scheme will continue to have the competitive edge.
Rupert Lea, Head of Retail & Retail Capital Markets de C&W España