Rising interest rates and poor debuts have led to expectations of a property slowdown, but many are nervous of calling the top of the market. The adoption of REITs in Germany and UK and the potential of emerging Europe are ensuring that pipelines remain bulging. How much will make it to market remains to be seen, as Owen Wild reports.
Property has been an increasing component of ECM volume since 2004. At that point deals such as the IPO of Fadesa Immobiliaria in Spain and the emerging market offerings of Globe Trade Center in Poland and Open Investments in Russia gained a very positive response from investors. Real estate has since grown rapidly with banks bringing a steady stream of offerings, mostly from Western Europe.
In 2006, real estate accounted for 11% of EMEA equity issuance over US$50m. In the first half of 2007 it increased further to total 15% and solidifies its position as the second largest sector in the region. And volume would be even larger if all deals that launched actually completed. Over the past two years, many IPOs, generally for fund structured vehicles, have soft-launched but never got as far as pricing. Often these deals have not even reached a bookbuilding period.
Due to the limited number of real estate specialist funds in EMEA, many of the investors participating in early deals were generalists. Consequently, the buyside was not always clued up on the sector, which eventually led to the listing of blind pools that often lacked a significant portfolio of assets and were completed at a fixed price. Investors were buying purely on the basis of management and what they thought could be achieved. One banker describes the success of these deals as the property sector’s dotcom bubble. In a similar fashion, demand for these vehicles collapsed in 2006.
Having learned from their earlier mistakes, investors now need to see a portfolio of assets as well as a pipeline of planned acquisitions to be made with the funds raised at IPO. Marketing sees investors study management’s track record and the portfolio. It is not just what is in the portfolio that is important, but also how the assets are managed and how management has maximised returns. It is for this reason that follow-ons have been better supported than IPOs as investors can see how management has delivered on what was promised.
Many bankers now believe that there has to be a pipeline of acquisitions to justify capital increases. In the case of German firm Alstria Office, which completed its IPO in April through Deutsche Bank and JPMorgan, the company was actually using the proceeds to refinance the acquisition of assets from Daimler.
While the asset pool has become more important, there is still substantial variety in the structure of the companies listing. Bankers and lawyers agree that both externally managed and internally managed structures will continue to co-exist with the success really depending on the assets themselves and management’s track record.
One particular issue for investors with externally managed funds is that the manager will earn a fee every time the fund successfully raises new equity. However, it is through those funds that investors can get access to successful management teams in which they trust. The result is multiple funds listed by advisers such as Dawnay Day that have met with success due to the firm’s record of delivering on its promises.
Dawnay Day completed the IPO of its third fund in May 2007, raising the maximum proceeds target of €300m. Dawnay Day Sirius offered exposure to German commercial property but differed from alternatives in this space by showing some initial success with developments. For example, Dawnay Day Carpathian was up 28% from IPO at the time of Sirius’ listing, and Dawnay Day Treveria, up 40%.
Ultimately, it seems that externally managed funds and internally managed companies can both succeed if they have the right assets, trusted management, and are offered at the right price. Structure can also be crucial.
Several REITs has listed successfully in the UK this year, led by Local Shopping REIT in April. But the largest test of the REIT market, Vector Hospitality, failed to price. Many investors thought the structure to be too complicated and in this case, an external management group with the conflict of interests associated, was not seen as acceptable.
Slowing
The strength of the property market has been underpinning the success of many IPOs in this sector. The relentless growth in property values over several years has led to an ever increasing amount of capital invested in property, both directly, and also through the equity markets. While nervousness has now crept in for analysts looking at property, percentage growth has continued in double digits every year.
“Real estate has been toppy for three to four years now,” said Paul Jayson, real estate partner specialising in international investment at DLA Piper. “There has been a yield compression as demand for property beat supply, yet it has still outperformed despite people calling the top of the market since 2002.”
The emerging European markets continue to be viewed as offering strong performance irrespective of whether Western Europe slows as expected.
“On a pan-European basis, many assets are down and equities trading below issue price makes marketing very difficult,” said one UK ECM head at a US house. “In emerging markets prices are lower and growth is better. There is a queue of issuance building from the region but there is an undersupply for real estate that will ensure demand.”
The year has already seen significant follow-on deals from Austrian firms that offer exposure to Central and Eastern Europe. As with other sectors, Austrian firms were among the first to invest in CEEMEA and as a result, Immoeast and Meinl European Land are now among the largest real estate firms in Europe. Meinl raised €1.5bn in a rights issue in February even though its previous rights issue was in November 2006. Immoeast similarly returned in May to raise €2.835bn on top of the €2.8bn raised in 2006.
The Austrian firms are focused on growth and as a result most do not pay a dividend. This might appear odd considering property normally appeals due to the attractive yields on stocks, but the success of the firms in converting the capital raised into attractive portfolios has ensured they have provided significant capital growth. Meinl states that it is still in a growth phase and therefore wishes to reinvest all profits.
Such a phenomenon would not be an option under REIT structures adopted by the UK and Germany this year. The legislation requires a payout at least 80% of earnings, meaning that these vehicles will be heavily skewed towards yield, with growth requiring regular follow-on capital hikes. However, with most investors seeking yield in this sector, strong demand for the vehicles should continue, but supply to date has been low.
Before the introduction of REITs in the UK, property funds headed to Jersey to achieve a tax efficient listing.
“We do have ‘REIT petite’ in Jersey that offers the same tax benefit as REITs, but it is not one size fits all. Some property owning vehicles want access to retail and achieve greater liquidity,” said DLA Piper’s Jayson. “Some property owning vehicles want to access retail and achieve greater liquidity. If starting from scratch then this may lead to the choice of London, but the cost of conversion may see existing vehicles remain in Jersey.”
While the UK has seen a handful of REIT IPOs, the first is yet to take place in Germany. Although the pipeline is understood to be growing, the final terms of REIT legislation have limited interest. The government specifically excluded residential property from inclusion in REITs, which means that many companies need to split out residential components of a portfolio before it can be listed. This was seen as a political move and new build property will be permitted for inclusion, which should encourage construction.
Sale and leaseback arrangements were also seen as a potential source of REIT issues in Germany, but the time and effort involved means many have chosen an alternative path.
“We see more consolidation in the real estate market moving forward, where private companies have ended up selling their property to bigger or listed players as it is so much faster.,” said Klaus Hessberger, co-head of EMEA ECM origination at JPMorgan. “Creating another company with a strong track record takes a long time as there is a need for separate historical accounts, building a strong management team and setting out a strategy. Plus office companies had to wait until they saw the final REIT law earlier this year before they could even start that process.”
Considering it took 18 months to prepare Alstria Office, REITs are expected to get off to a slow start in Germany.
There is also expected to be an increased specialisation in the funds that come to market across Western Europe. The US has seen REITs offer exposure to portfolios as specific as Florida supermarkets and market observers believe there are similar opportunities in Europe with city and commercial-use specific REITs expected. The hope is that the specialised REITs can gain a better reception by virtue of their niche and achieve better valuations than their generalist peers.