Real estate investment trusts were invented in the US in the 1960s. Some now have more global ambitions, but theirs is fundamentally a local business, writes Michael Lester
Real estate investment trusts (REITs) were established in 1960 in the US to give investors, large and small, the opportunity to invest in portfolios of commercial real estate. The industry has grown from a handful of regional real estate companies to more than 180 listed REITs (most of which are traded on the New York Stock Exchange) with a total equity market capitalisation of more than $660bn (€503.7bn).
The primary US REIT property types are industrial, lodging/resort, office, residential and retail. In the past decade or two, healthcare, timber, cell-tower, senior-housing, self-storage and student-housing REITs have been added to the mix. Some of these newer property types have performed extremely well. Over the past 10 years, for example, both healthcare and self-storage REITs have delivered total returns in excess of 20%.
In the first quarter of 2013, the REIT industry had an average return of 9.1%; over the past 12 months its rate of return has been 18.7%. The industry is big and successful, but most REIT executives are cautious in their risk-taking, especially when it comes to overseas investments.
US REITs can find many good reasons for not investing in Europe.
Europe has different laws and regulations. The languages are different. The development and property codes are different. Cultural practices vary greatly. Changes in currency valuations always add confusion.
“One of the most difficult issues is tax structure,” says Guy Jaquier, CEO of Prologis, the largest of the industrial real estate companies, “because REITs don’t pay taxes in the United States, but they do in Europe.”
These are all good, valid reasons to stay at home. But what about those REITs that do invest in Europe? What makes them think they are so special?
What hotels and warehouses have in common
Hotels in Europe have a solid base of repeat US customers. Connecticut-based Starwood Hotels and Resorts, for example, owns and operates more than a thousand hotels in a hundred countries worldwide. Its European roster includes 15 upscale hotels: Sheratons in France, London and Spain; Westins in Austria, Ireland, Italy and Spain; and W’s in London and Spain. If you have been to one, you have been to them all.
Another REIT, Host Hotels, has more than 100 luxury and upscale hotels in its international portfolio. Host hotels are typically located in the central business districts of major cities, near airports and resort/conference destinations that, because of their locations, typically benefit from barriers to entry for new supply.
Host has about a one-third partnership interest (about $305m) in a joint venture in Europe with APG Strategic Real Estate Pool NV, an affiliate of the Dutch pension fund APG, and Jasmine Hotels, an affiliate of the real estate investment arm of the government of Singapore. This joint venture owns and operates more than 6,000 rooms at Westins in Madrid, Milan and Venice; Sheratons in Hayes (UK), Rome and Warsaw; Renaissances in Amsterdam, Brussels and Paris; Marriotts in Brussels and Paris; Le Méridiens in London and Nuremberg; the Crowne Plaza in Amsterdam; the Hotel Arts in Barcelona, and the Pullman Bercy in Paris.
According to its latest 10-K filing with the US Securities Exchange Commission, Host intends to use joint ventures to expand its global portfolio. “With our investment in Europe, we’ve focused on destinations that attract both domestic and foreign travellers, as we believe international demand helps to retain and increase asset value over time. Our focus is on markets like London, Paris, Munich and Berlin where we believe opportunities exist to acquire quality assets at reasonable premiums to our cost of capital and significant discounts to replacement costs.”
Jaquier says: “In the hotel sector and, in our case, in the industrial sector, the customers are global. Ritz Carlton customers, for example, know what to expect, whether it’s a Ritz in Paris or a Ritz in Shanghai. There may be other hotels in those cities run by great operators but, if you don’t know them, you go with the brand you know and like. The same logic applies to industrial. Our customers are the global supply chain – DHL, Federal Express, the people who move boxes around the world. If you’re a global logistics company, your customers know what to expect.”
Industrial REITs were the first to venture into Europe, and Prologis was one of the first of those companies. “They are often working with the same tenants,” explains Michael Grupe, executive vice-president of research and investor outreach at the National Association of Real Estate Trusts (NAREIT). “For example, Prologis owns logistics facilities in and around major transportation hubs, such as JFK Airport in New York and Heathrow Airport in London, that may be leased in part by the same tenant, such as FedEx.”
Jaquier says: “We work with French and Swiss companies that do business in China and Latin America. We work with Japanese companies that do business in Europe. It is an advantage to be able to deal with these customers at a global, strategic level. They’ll say, ‘We want a building in Guadalajara, we want a building in Warsaw.’ And we’ll say, ‘Okay’ because we have a global platform.”
Prologis owns 588 buildings covering 140m sqft in 14 countries in Europe. “We’ve been a big presence since the late 1990s. We helped create the institutional investment market in logistics in Europe,” says Jaquier proudly. “Fifteen years ago, investors were in office buildings, hotels and retail, but industrial wasn’t on their radar screens.”
Prior to the European Union, real estate companies were more geographically confined – they focused on cities, on countries, sometimes on regions. But now, says Jaquier, “you can have one big logistics facility, say, in Lyon, from which products are distributed to Spain or Italy. You can aggregate your facilities into larger, more efficient networks, and that’s created an opportunity for developers to build large-format facilities that weren’t in existence before the EU.”
European warehouses were built to store products for days, for weeks, often for months. But today’s global shippers, like Amazon and DHL, usually store their products for hours, sometimes mere minutes. Nobody wants inventory. Nobody wants their goods just sitting around. ‘Warehouses’ have become ‘distribution centres’.
“Believe it or not, Europe is an immature market. We estimate that only about 15% of the logistics stock in Europe is ‘modern’. The US has roughly triple that,” says Chris Caton, head of research at Prologis. By modern, Caton means bigger (up to a 1m sqft), taller (ceiling height above 10 metres, whereas an older facility could be half that), and expansive truck courts (so that trucks can easily park and back in and out of the huge, surrounding parking lots).
It’s a mall world
So, a hotel REIT reaching into Europe seems reasonable, as does the expansion of industrial REITs. “But there are entire sectors that don’t make any sense,” says Ralph Block, pre-eminent REIT historian. “If a US apartment REIT decided to venture into Europe, I would say: ‘What?!’ The housing markets in Europe are more heavily regulated, and the REITs would have a real burden of proof to US investors that they can bring anything to the party.”
Block has been a student of and investor in REITs since 1974, first as an individual and then as an adviser, analyst, portfolio manager and, for about six years, as the manager of a REIT mutual fund. Block currently writes a weekly report about REITs.
In addition to residential REITs, Block thinks that office REITs should stay on their side of the pond. Boston Properties, one of the biggest office REITs in the US, was initially interested in entering the London real estate market. It looked closely at going into the UK but, in the end, there was no deal. Boston Property is not alone. Office REITs in the US have not made any significant property investments in Europe.
However, Block does see the value in big retail REITs going global. “One reason to go global is if you can leverage relationships.” Block points to Simon Property Group as having an advantage here.
Simon is the largest real estate company in the world. The REIT has five retail platforms: regional malls, premium outlet centres, The Mills, community/lifestyle centres and international properties. It owns or has an interest in almost 400 properties comprising 24.5m sqm of gross leasable space in North America, Europe and Asia. The company is headquartered in Indiana and employs 5,500 people worldwide.
In early March 2012, Simon acquired a 28.7% equity stake in Klépierre for €1.5bn. Klépierre is a Paris-based real estate company that owns, manages and develops shopping centres, retail properties and offices across continental Europe. Klépierre’s portfolio includes 271 shopping centres in 13 countries, with 50% of its properties in France and Belgium, 25% in Scandinavia, and the rest in central and southern Europe.
“Simon has established relationships with many global retailers and European-based retailers,” says Block, referring to high-end retailers like Tiffany and Louis Vuitton. “It might be able to use those relationships to develop or re-develop centres in Europe and bring in those tenants who wouldn’t come if the space were owned by an unfamiliar company.”
The other big reason for REITs to go global, according to Block, is that REIT managers think highly of themselves. They boast of having best practices, of being more advanced as real estate owners than European companies. “They argue that they’ve been institutional real estate owners for a long time,” he says.
“They are vertically-integrated organisations; they think they know much more about leasing and property management; they do it more efficiently; yadda yadda yadda. In some cases, to some extent, that American superiority may be true. For example, I would be more willing to accept Simon’s activity in Europe than I would a smaller, less global company’s involvement.”
Boots on the ground
Prologis has an extensive infrastructure. “We have 388 boots on the ground,” says Jaquier, referring to staff in Europe. “Times two,” adds Caton, jokingly, counting two items of footwear per employee.
Digital Realty also manages its own properties. The new REIT (it went public in late 2004) specialises in data centres – large high-tech buildings focusing on company security and connectivity. Digital Realty’s 122 properties are located in 32 markets throughout Asia, Australia, Europe and North America. It owns data centres in Amsterdam, Dublin, Geneva, London, Manchester and Paris.
Digital Realty’s managing director in Europe, Bernard Geoghegan, who oversees a real estate staff of more than a hundred, says: “Despite the influence of continuing economic uncertainty in Europe, demand for data-centre space remains strong,” he asserts.
“Security and disaster recovery requirements remain at the forefront, particularly in light of recent global events, so it is critical for suppliers to demonstrate a strong pedigree in being able to deliver appropriate solutions.”
Simon, taking the other route, entered into a joint venture with a French-based company. Grupe believes that “if you’re going to operate in another country, you’d be well-advised to develop relationships with local partners so that you benefit from local expertise.” But Block points out that the REIT is then “subject to all the complex intricacies of joint ventures, so it may not totally control the properties. It is also giving up a good amount of upside if the venture works out.”
Some REITs inherited their infrastructure. Earlier this year, two major residential REITs – AvalonBay Communities and Equity Residential – completed their acquisition of Archstone Enterprise from Lehman Brothers Holdings. The assets consisted of high-quality apartment communities: a total of more than 45,000 rental units as well as development and land sites. The $16bn deal included interest in a portfolio of apartment communities in Germany with a gross value of approximately $500m. The REITs are co-managing these assets until they are sold or assigned. They have no long-term goals of investing in Europe.
Public Storage, the world’s largest owner and operator of self-storage facilities, took over 189 self-storage facilities from Shurgard Storage Centers when it acquired that REIT in 2006. The 100,000 self-storage units are in seven countries: 55 facilities in France; 40 in the Netherlands; 30 in Sweden; 22 in the UK; 21 in Belgium; 11 in Germany, and 10 in Denmark.
Self-storage is a stable and solid REIT sector because of Americans’ penchant for moving house and keeping all kinds of personal belongings long after they have meaning or a place in their new home.
According to Marc Oursin, CEO of Shurgard, who oversees Public Storage’s operations in Europe: “The self-storage industry in Europe is a young industry compared to that in the US – 15 years for us compared to more than 40 years in North America. The difficult economical situation of Europe could slow down the development, but the fundamentals
are positive and the potential is significant.”
Real estate is a local business. REITs have developed their expertise in the US. They know locations here; they know tenants here. On the other hand, some real estate companies – such as high-end retail, hotels, data and distribution centres – have a global perspective.
“It’s possible that US REIT investors might be receptive to an intelligent foray into Europe, but in most cases they would be sceptical, especially with the uncertainty today about the European economy,” says Block.
Jaquier speaks from experience. Venturing into Europe, he says, “is not for the faint of heart.”