From equities and debt to commodities and credit, the financial world is a scary-looking place for investors. Plenty of black spots can be found in real estate: everyone knows about the problems in US residential markets that helped trigger cross-asset-class deleveraging and risk aversion. The same mortgage market distress can be found in the UK and Spain, while offices have been feeling the pain for some time and there are growing indications that retail property is also set to suffer as consumers rein in their spending habits.
It’s not all doom and gloom, though. Without trying to downplay the severity of the present conditions, some market participants are already looking to the future. "The mood among investors is one of caution and uncertainty. But it should also be one of future opportunity," says Kiran Patel, global head of research, strategy and business development with Axa Reim in London.
Patel is speaking from experience. In December 2001, Axa Reim launched an opportunity fund that invested in speculative office developments in France. It was a tough sell: three months after the September 11 terrorist attacks in the US there was strong aversion to towers, interest rates were dropping like stones, and confidence generally was low for occupiers and investors alike. "It seemed like the worst time to be launching a real estate opportunity fund," says Patel. "But, in hindsight, the time to do these things is when conditions are really bad."
The fund invested close to €1 billion in French office developments over the following four years and began to sell out in 2006, closing last year and delivering investors returns in excess of 20%. A second, similar fund that has still to mature looks on course to achieve the same success.
Of course, it takes luck – and courage – to catch a market at its low point, and in Patel’s opinion that point hasn’t yet arrived at this phase of the cycle. Unlike previous down cycles in real estate, the present stress was not caused by oversupply, he says – instead, it was prompted by a glut of cheap money, which emboldened buyers and resulted in unrealistic prices and too much leverage. "That is the source of the pain and is what now has to unwind. As a result, the demand side will be affected, but we see that as a lagging response. Although you’re not seeing it today, in our view it’s about to come, and its effects will be felt more in 2009 than this year for real estate," he says.
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| "Our message to clients is – if we advise you to do something, do it now – don’t wait" |
More positively, Patel says that pricing has already begun to adjust to more straitened times and by the time that demand has been throttled back, prices might already be low enough to present fairly diverse opportunities: "We are telling our investors that there is no hurry to get in but to start phasing some money into real estate from 2009 onwards. They shouldn’t be ploughing everything in at once but if they’re thinking about being fully invested by 2011, that looks like a good position to be in – and you’ve got to be in the market to see the deals, to take advantage." Patel sees high-end retail space in prime, capital city shopping locations as a good opportunity. He argues that pricing has already adjusted for these properties and they might represent good value for investors willing to take a long-term view. "For example, operate in the core space – key high street locations – the most recognizable names being Oxford Street, Regent Street, the Champs Elysées – they are core assets and now is the time to pick them up if you can, subject to vendors being realistic on current pricing. You will walk away with maybe low-single-figure returns in the short to medium term but they will prove their worth in the next boom, and in that environment everybody wants to be in those locations."
Real estate distress hasn’t stopped Axa Reim from buying, says Patel. Up to the end of May, the company had completed 60 deals for an aggregate volume of €2.8 billion. A further 25 deals worth €1.6 billion were in the pipeline, and the company had been sellers in 100 deals, worth €1.5 billion. In 2007, it acquired €5.7 billion and sold €3.9 billion, but Patel says this year’s activity shows that the company is not sitting on its hands: "We don’t need to have volume growth every year – it’s about staying active. It shows we are still in the market, it shows Axa Reim still has a huge presence, so vendors who are out there are coming to us because they know we are serious players, they know we have a variety of mandates, and that’s appealing."
As an example, one of Axa Reim’s recent deals involved the firm acquiring a portfolio of 57 hotels from Accor (eight of which are still to be developed) in a hefty €470 million transaction. Accor will continue operating the hotels, leasing the properties from clients represented by Axa Reim, which looks after the portfolio from a fund management perspective, approving budgets and managing cashflows. "We call it a sale-and-manage operation. Accor wanted the properties off its balance sheet, but still wanted to be the manager of the hotels," says Patel.
Interesting deal
Raising the finance for a portfolio of that size was not easy. Four banks were involved in the deal – BNP Paribas, Calyon, HSBC and Natixis – and as the markets moved around, terms had to be negotiated several times, says Patel. In total, it took about three months to pin down. "We were talking about hotels that are spread over France and Switzerland, so you have two different territories; one is part of the European Union and the other isn’t, so there were those issues to deal with. The hotels all had different structures and management contracts so there was a lot to go through. But we think it’s a very interesting deal and was worth the time and effort. Given the size of the deal, Axa Reim was also able to offer co-investment opportunities," he says.
The crisis has given Axa Reim a chance to flex its research muscles, and the company has been strongly advising clients to tackle problems before they have a chance to fully manifest themselves. "We have strong opinions on a lot of markets and our message to clients is – if we advise you to do something, do it now – don’t wait," says Patel.
Patel says that the company started warning clients in very strong terms about the UK as early as April. "We put out a strong message saying that we thought the market was overheated and that clients should move to an underweight position – we told them to skip being neutral and just go straight to underweight." Some might have done so, but Patel says that others didn’t immediately react and when it became evident that parts of the UK market were in for a sharp correction, some of Axa’s own funds were caught in the crossfire.
"Some of our unit-linked funds saw some pretty significant outflows, starting in the fourth quarter of last year, but they’ve tailed off in the last two or three months," he says. Part of the problem is that other managers had offered funds that mixed physical assets with exchange-traded real estate assets, such as shares of real estate companies, or real estate investment trusts – the volatility of these assets contributed to an overly negative reaction: "We didn’t do that. We were pure on the physical assets. But some of the listed stuff proved to be immensely volatile, and that contributed to a sense of panic across the market."
Axa Reim came into existence in 1999, when the real-estate investment arms of the insurer’s seven national subsidiaries in Europe were brought together and merged into a single entity. "You have to credit the group with great foresight," says Patel. "They saw the introduction of the euro, they felt that cross-border trades would increase, they also felt that real estate would become more internationally traded – at least in Europe – so they set about taking all of these seven individual stand-alone real estate companies and bringing them together to create one pan-European real estate company. That’s how Axa Reim was born."
In the space of a decade, the company has changed dramatically. In 1999, seven countries were covered; today, Axa Reim has a physical presence in 12 European countries and investments in 19. At the same time, the company has ceased to be Axa’s in-house real estate manager – roughly half of the assets under management are now owned by external clients; previously, 95% belonged to Axa’s insurance companies. And the assets themselves have grown from €17 billion to €42 billion.
Another big change came in 2004, when the company was looking to expand its geographical continental coverage. It could have moved further east in Europe, targeting such markets as Russia, Turkey and Ukraine, says Patel, but that would simply have added to the company’s existing European infrastructure. Instead, Axa Reim wanted to be able to offer its investors more diverse opportunities and, for that reason, chose Asia over the more mature and monolithic US. "What Asia gave us, unlike the US, was the ability to target all sorts of different risks, different profiles, different economies. China and India are emerging markets, very opaque – that offers the kind of inefficiencies that can make things very attractive for a good manager. Japan is very sophisticated, as are Singapore and Hong Kong, but the latter give you access to some of the less-developed, surrounding markets, too," he says.
Fund of funds
Axa Reim started its Asian expansion in Tokyo, where it now has an office of eight real estate professionals, has three client mandates, and is in the process of putting together a fund in order to capture a wider range of clients. The company also has an office in Singapore from where it is building a pan-Asian fund-of-funds business, and a roll-out of other Asian funds. India is also a strategic target where the firm is in the process of building a local platform. "In Europe today, you can find a number of managers who can offer genuine expertise in a number of domestic markets simultaneously – but in Asia, there are not many people who can offer expertise in, say, India, Taiwan and South Korea," says Patel. "So although Asia is following the European trend towards commoditization of real estate, a big difference is that there has been slow growth in indirect investment vehicles – we knew that some of our clients would want to go down the fund-of-funds route."
In other respects, Axa Reim’s model has not changed. In Europe, the company still believes in having local real estate professionals working their domestic markets, says Patel – and the same approach is being followed in Asia: "At the group level, we have skills in things like corporate finance, research, strategy and fund management. Those are exportable. What is not exportable is deal execution and asset management. For that, you need local people."