Understanding the language of real estate is not always straightforward because in many cases there is no standard agreed definition. But is standardisation a goal worth pursuing? Christine Senior investigates
Calling a spade a spade is not always easy in real estate. One researcher's definition of prime property could well be understood as secondary property by another. Some basic terms which are at the heart of real estate investment have no commonly agreed meanings. Comparing like with like is impossible.
While prime property has no standard definition, it is easy to fall back on a subjective vague description such as prime properties are the highest specification buildings, in a good location. But a prime building in the City of London will not be the same as a prime building in Warsaw. Another way of looking at it is that prime property is the top 10% of real estate stock.
"[In defining prime] it's difficult to be definitive across markets," says Michael Haddock, director of EMEA research at CBRE. "For example, does a prime office building require air conditioning? If you are in the City of London at the moment the answer is yes; if you are in Zurich that might not be the case. In Zurich they have fairly strict emission standards that means it's quite difficult to put air conditioning in a building in the city centre. Therefore air conditioning is not absolutely necessary for a building to be prime."
The Pan European Property Common Interest Group (PEPCIG), an informal group of interested parties from the industry who have concerns about these issues, has come up with a number of recommendations to determine a definition of prime - prime should be best in class or close to best in class in its respective market and of appropriate standard and size for the market. "That looks like a bit of a fudge," says Haddock. "It leaves it open to subjectivity, but going the other way creates anomalies that would be equally damaging. It's a trade-off."
If defining prime property is tough, defining secondary property is a well nigh impossible. CBRE is making internal efforts to provide consistency in definitions of terms such as prime and secondary yields through consultations between its various offices around Europe. Agreeing on the elements that make a prime building provides a starting point to finding a definition for secondary property. Prime office property has to be a building of high technical specifications, in the best area of the city, let to a good quality tenant, on what is regarded as a long lease for that particular market.
"From the perspective of prime yield you would have to tick all those boxes in order to be considered prime," says Haddock. "That gives you a language to start talking about what constitutes secondary. For example is a secondary building one that ticks three out of the four boxes? Can you think about a tertiary building being one that ticks only one of those four boxes?"
At Jones Lang Lasalle, the definition for secondary and tertiary property is taking a slightly different form. There is not standard definition within the market, agrees Petra Blazkova, head of EMEA capital markets research.
"You have two aspects: the location and quality of the building, then there is the occupier. We define secondary as really the highest quality building which is not located in the CBD, in the prime location. So it's the highest quality but in a B location. That is one way of looking at it. In tertiary, the quality of the building is not good, it lacks one of the core technical specifications. It would be a B grade building in a B location."
Defining what constitutes prime retail property involves looking at still different criteria. The elements involved here are more concerned with the area served by a shopping centre as well as its size and quality, says Anne Breen, head of property research at Standard Life Investments.
"A prime shopping centre in our view is not necessarily just based on its location, it's the size of the centre and its dominance in that region - so where it's the dominant centre in terms of drive times, where it has floor space over a certain area, which might be over 500,000ft2, if it's prime in quality, that is considered a prime shopping centre. It becomes more difficult to define what secondary would be. We tend to look at its price relative to the prime and the average in that region."
Geographical terms are also a source of confusion. CBD is a rather woolly term, particularly in Europe when compared to the US. In some cities it might be a couple of streets; elsewhere it might cover a large area, with fringe areas that brokers might or might not include within the CBD. In the major cities of eastern Europe - Prague, Warsaw, Budapest - local researchers have come together to agree a definition of CBD, so for these three cities CBRE, JLL, DTZ and Cushman & Wakefield all sign up to the same meaning. In Paris Immostat, owned by some of the principal brokers, has defined eight principal zones, including the CBD, Paris Centre West, Southern Paris and La Défense. But London is more complex with its extensive centre subdivided into West End, City, midtown and Docklands, with no commonly accepted definition among brokers.
And any attempt to come up with a set of agreed definitions could invalidate historic data already held.
"We have years and years of historic data defined on the basis of boundaries we are currently using," says Haddock. "We wouldn't necessarily be able to recreate that because perhaps we haven't kept all the individual transaction information over 20 years. We have a lot of sunk value in our existing definitions."
Definitions of property types in any case are not static. Developments can make previously economically distressed districts into much sought after centres. Thirty years ago London's Isle of Dogs was the location of poor housing stock and dated and disused docks. The Dockland development has created a completely new extension to the City of London.
The economic cycle also affects what researchers and investors regard as prime or secondary property. "It's cyclical," says Mark Callender, head of property research at Schroders. "When the market is very hot the proportion of things that are prime probably rises 20 or 25%. The proportion of tertiary property probably shrinks as well. People at that point are not paying full attention to all the risks."
Henri Vuong, property research analyst at Prupim, agrees that the definition of prime widens and narrows depending on the state of the economy. "At the end of 2007 what investors regarded as prime narrowed significantly because no longer was the best building in best location good enough. It became the building with the strongest tenant covenant. During that time when the country went into recession long leases became really attractive."
The opposite applies in an upturn, Vuong says: "When the market is rising investors prefer a shorter lease because then they may be able to relet the building at a higher rent."
Yield is another area of huge divergence of standards, and a topic currently under discussion by PEPCIG members to try to bring some consistency of meaning. In the UK yields are typically net, with the tenant responsible for all repairs and insurance under the terms of the lease. But in most of Europe the landlord takes on the burden of much of this, which of course can reduce the net yield substantially for the landlord.
Lack of clarity in how rents are shown is also evident. Incentives in the form of rent-free periods can have a major impact on the effective rent, but it is not always clear whether figures quoted are headline rent or effective rent. If a rent is quoted for a 10-year lease, but the tenant is offered a rent free period of two and half years, that reduces the effective rent by 25%.
"Probably 80% of the time it is the headline rent that is quoted, but what the investor wants to know is the net effective rent," says Callender. "In general it is the headline rent that is reported in the press, not the incentives. Incentives is a pretty grey area."
But the way deals are structured also affects how the yield is calculated. Take Belgium and Ireland: the transfer tax for direct real estate transaction is 12.5% in Brussels and the Walloon region but property transactions are usually structured in a company special purpose vehicle using a share transfer which attracts stamp duty at only 1%.
"If you come up with a definition of net yield which assumes you pay direct transfer tax you would be understating returns in Brussels," says Haddock. "That already happens for Ireland where transfer tax is around 9% and the standard approach is to assume you pay that 9%, but a very high proportion of transactions are structured in SPVs so most investors don't pay that. On the basis that yields are stated, they understate the yield in Ireland."
Not all those involved in real estate agree that standardisation of terminology is necessarily a goal worth pursuing. It can be argued this lack of common standards and inconsistencies in interpreting terminology give firms a chance to stand out from the crowd by trading on their own expertise in interpretation of data. It presents a marketing opportunity.
"Why don't brokers agree?" asks Peter Hayes, director of research, Europe at Pramerica Real Estate Investors. "I think the brokers like to see themselves as having the expertise in the market. It's a way of trying to separate them from their competitors, to say we know the market better than you do."
Brokers, he says, have no particular interest in providing what researchers want. Individual transactions are important to them, but not aggregating that data into something that would be useful for researchers. While fund managers need to be able to consider the market holistically to make comparisons between markets, the lack of consistent market data is not the biggest problem.
"Strong management teams are on top of the markets they operate in," says Hayes. "Market analysis can be managed by employing large research teams who can pick their way through the data. There is no real demand for brokers to collectively produce a comprehensive and consistent set of data and data definitions when research teams can filter it just as well."
At Henderson, Nick Evans, fund manager for the Henderson Indirect Property Fund and head of the European indirect multi-manager business, supports this view. His firm's expertise in interpretation of inconsistent data is a means to distinguish it from others.
"We have so many investment professionals in the various markets themselves, we have a central core research team that looks all the data, all the differences between markets," he says. "It enables us to compare and ensure that we are underwriting a transaction on the same basis, that we are taking into account all the idiosyncrasies between markets. It puts myself and some of the more well-supported institutions and investors at an advantage in that respect. It provides us with an opportunity to create further value."
But Evans is keen to emphasise the need to have partners on the ground in the various markets to ensure first-hand information.
"It's a challenge to compare like for like," he says. "That lends itself to ensuring you have partners in the respective markets so that you truly, truly understand what you are getting yourself into, so that you can make a decision and compare consistently across markets."
Nevertheless much progress has already been made in bringing some clarity to a topic fraught with inconsistencies and ripe for misinterpretation. PEPCIG has made great strides and is continuing to work on the outstanding issues.
Elsewhere providers are offering more comprehensive data that enables better comparisons to be made. PMA's analysis and forecasts have produced information alongside explanations of differences, and RCA and CoStar provide transactional information which allows investors to compare buildings and markets. Now valuations can be challenged because there are more desktop sources of information about transactions available.
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