After the market turmoil of the last few years the sovereign debt crisis has strengthened investors' focus on Europe's stable, core markets especially the new favourite, Germany and further emphasised the importance of market timing. Meanwhile will pessimism about Southern Europe create opportunities? Richard Lowe sought views from a range of stakeholders

Peter Olsson
AP Pension
Sovereign debt crisis has had a limited impact on European strategy
It has underlined the importance of focusing on specific country risks
Greece and Spain never been high on the agenda

Denmark's AP Pension was fairly active in the European real estate markets in 2010. It made some direct investments in its domestic market, but also committed capital to a UK-focused real estate fund managed by Rockspring Property Investment Managers.
Peter Olsson, head of property at the pension fund, says there is still potential to make new investments in European real estate and that the sovereign debt crisis has had a limited impact on this appetite. For instance, it has not led to a change in strategy or prompted AP Pension to focus on different markets over others.

If anything, it has lent support to the pension fund's existing views of individual markets in Europe. "The sovereign debt crisis has underlined our opinions about different markets," Olsson says. "But it's not that we have changed investment strategy, or that before we were looking at something and now we are looking at something different. It has affected in some ways how we look at different countries, but it hasn't really meant that I had something in the pipeline before that I don't have anymore."

Olsson says that focusing on specific country risk and the macro-economic picture of each market has always been a primary consideration at AP Pension. "The debt crisis has just proven that it was the right thing to do," he says.

Greece and Spain, for instance, have never figured heavily on AP Pension's real estate investment agenda. "What has happened has underlined our previous concerns," Olsson adds.

By contrast, Germany and the Nordic states have more stable economic and financial outlooks, but Olsson points out that AP Pension already has a significant exposure to these markets, particularly Denmark. This does not mean that the pension fund will not make new investments in these regions, but it needs to consider its existing portfolio before committing new capital.

"We are always eager to see what is going on in different markets. We are looking for good opportunities," Olsson says. "We are looking at all possibilities."

Jeremy Plummer
CBRE Investors
More cautious on Southern European markets as a result of the crisis
Germany is attracting capital as a result both directly and indirectly
There are exceptions in troubled markets for the very best prime assets

CBRE Investors is more cautious on Southern European markets as a result of the sovereign debt crisis, as are many other investors, says Jeremy Plummer, head of global property multi-manager at the firm.

"It is resulting in investors concentrating on the markets where they see that risk being lowest," he says. "The flight to safety and risk aversion, which is definitely going on, means that people have Germany at the top of their real estate buy-list, which has now taken over from the UK."

Plummer says the trend towards Germany is a result of the sovereign debt crisis, both directly and indirectly. "A direct consequence is you don't want to go to countries that have that problem, so you focus on Germany," he says. The indirect consequence is that the better fiscal situations in countries such as Germany improve the outlook for their domestic real estate markets. And so there is a kind of "double reason" to focus on markets that are less threatened by the debt crisis.

But while affected countries, such as Spain, have seen a withdrawal of cross-border capital from their markets, there are some exceptions. "There have been one or two significantly sized transactions in Spain where the bidding has suggested the pricing is quite keen," Plummer says. "If it's a very good shopping centre asset, for example, there is international investor interest. But it's at the ‘super' prime end only; anything below that, there is zero interest."

Plummer says this suggests top assets let to strong international retailers in countries such as Spain might even be viewed as more secure investments than the sovereign debt. "The risk premium on the prime asset looks very low given that the sovereign debt is at a big spread relative to German bonds," he says. "But maybe the risk premium should be negative. In the Armageddon scenario where the government defaults, wouldn't you rather own a building with strong corporates paying rent?"

For the majority of international investors the decision to leave those markets embroiled in the sovereign debt crisis is an easy one to make for the time being.

Marleen Bosma-Varhaegh
Blue Sky Group
Favouring Germany and the Nordics over Southern Europe
But the sovereign debt crisis has not changed real estate strategy
The wider global financial crisis has had more of an impact

The sovereign debt crisis has had an impact on the way in which Blue Sky Group, which manages the investments of a number of Dutch pension funds, views real estate markets in Southern Europe compared with other markets, such as those in the Nordic states. However, it has not brought about a material change in strategy.

The fund manager for global real estate at Blue Sky Group, Marleen Bosma--Verhaegh, says the company's non-listed real estate portfolio in Europe is designed to offer diversification across Europe and due to the illiquidity of the closed-ended fund structure is difficult to alter quickly. "You really have to focus on setting up a broad diversified strategy for the long term, so the whole port-folio does have a cushion to provide for these specific sovereign debt conditions from country to country," she says.

It is the global credit crisis that continues to have more of an influence on strategy. The credit crisis changed some of Blue Sky Group's underlying assumptions for real estate and this led to a revision of its investment strategy, which is based foremost on asset liability management studies.

For instance, the crisis showed that non-listed real estate could move with more volatility than widely assumed and so the risk profile for the sector subsequently changed. Bosma-Verhaegh says these changes in assumptions, or expectations, for the different sub-sectors of the real estate asset class (Blue Sky Group invests both in non-listed and listed real estate, as well as direct property through an external fund in the Netherlands) led to a change in strategy. "We increased the domestic portfolio, we changed our focus within the international non-listed part and we decreased the listed real estate," she says.

The sovereign debt crisis in Europe has not changed Blue Sky Group's underlying assumptions in such a way. But it has had an effect on the timing of investments, so that Blue Sky is more focused on Germany and the Nordic states today than Southern Europe. "We now would focus more on Germany or the Nordics, which are not that influenced by sovereign debt, compared with Southern Europe," she says.

Louie DiNunzio
Cadillac Fairview
Sovereign risk was a key factor when identifying European markets
Focused on the UK market, so sovereign debt crisis is somewhat peripheral
But this could change when the time is right to move into continental Europe

Cadillac Fairview is a wholly owned subsidiary of the Ontario Teachers' Pension Plan and manages the institution's real estate exposure. Over the past 10 years it has sought to rebalance its portfolio and reduce its heavy weighting to Canadian real estate by diversifying into foreign markets. The company identified the UK market as its first step in Europe and has no plans to move into continental markets just yet.

Louie DiNunzio, senior vice-president of investments at Cadillac Fairview, explains that sovereign risk was a very important factor in deciding to focus on the UK and will be an equally significant consideration when it looks to invest further into Europe in the future.
"We looked at sovereign risk spreads as one of many different filters that we used to figure out where we wanted to go," he says. "It's an indicator of political stability, of political risk. So right away the UK was at the top of the list." There were, of course, other important considerations: the legal system, accounting principles, market liquidity; economic outlook.

"The UK market is so large, is so liquid, the -reality is you really need to build a critical base in a particular geography," DiNunzio continues. "Spreading ourselves thin by trying to invest in too many things I don't think would be the appropriate thing for us to do. That is why we have chosen to focus on the UK."

For this reason, the sovereign debt crisis in Europe is somewhat peripheral to Cadillac Fairview's current activity. But this could easily change. "If we were to start to analyse what markets we would like to go into after the UK, our analysis would be the same," DiNunzio says. "We certainly would take it into account. Where you have more stability, where there is less political risk, would certainly be where we would go."

The sovereign developments in the UK have also served to reinforce Cadillac Fairview's decision to target the UK. "It was the right starting point for entrance into the UK and continental Europe," DiNunzio says. "It has proved to be quite stable. The government has proved to be very proactive in dealing with issues; it has not let them fester."

Leo de Bever
Alberta IM Corporation
Pessimism in Europe is overstated
This creates opportunities for long-term investors
Looking for niche investments, such as infrastructure

Leo de Bever, chief executive and chief investment officer at Alberta Investment Management Corporation (AIMCo), believes the pessimism in Europe around the sovereign debt crisis can create opportunities for long-term investors. AIMCo, which invests on behalf of 26 pension, endowment and government funds in the Canadian province of Alberta, has a number of real estate and infrastructure investments in Europe, and is looking for other new opportunities.

"People have gone from not worrying about it at all to worrying about it too much, and in some sense that creates opportunities," he says. "People are so depressed about certain jurisdictions. We look at it from a longer-term perspective and we figure it will pass."

AIMCo has a large exposure to core real estate in Canada and so pursues a more opportunistic approach in Europe, often looking for investments that "fall between real estate and private equity, or real estate and infrastructure". He explains: "Things that don't fit any box particularly well. We feel that is where the good opportunities are, because there is limited capacity for institutions to look at them."

De Bever says he would not want to invest in Greece or Italy at the moment, but he does think the threat of political turmoil in countries with troubled national finances is "probably at this stage exaggerated". He continues: "If you keep your head and you don't need to make money tomorrow, that creates opportunities. The challenge for pension funds is to behave in a long-term investment mode. Too often they get too caught up in short-term worries about the moment."

AIMCo has some existing infrastructure investments in Spain that at the current time "do not look too good on a mark-to-market basis". But de Bever has a reasonable confidence that countries such as Spain "will find their footing".

He adds: "There are some other places that I do not really want to go. But in many cases it's not the capacity to pay or the downright creditworthiness of the country, it's the willingness of the local politicians to deal with the issue in hand."

Stephen Ryan
Sovereign debt crisis is peripheral to those focusing on France and Germany
Non-European pension funds have not been put off by the crisis
Some investors see real estate as safer than government debt

When investing in continental Europe, France and Germany are the two main markets of focus for pension funds based outside the region. For this reason, the sovereign debt trouble plaguing Southern European economies is somewhat peripheral, says Stephen Ryan, senior investment consultant at Mercer.

And even the wider implications for Europe as a whole have not led to perceivable reduction in appetite for continental European real estate investment. "Pension scheme investors typically take a long time to make decisions on property," Ryan explains. "If, say, they have been thinking about investing in continental markets for a year, they haven't actually been put off their stride by the recent crisis, because it is a long-term strategic decision." He cites a client that recently decided to go ahead with a new allocation to continental European real estate. "They may have taken more time and due diligence, but it didn't put them off."

For those investors that do look beyond France, Germany and the Nordic states, Ryan is aware of two very divergent takes on the situation. He says some investors are shunning such markets as Spain and Portugal because property yields have not risen in line with yields on local sovereign debt. "Investors typically price property from the risk-free rate plus a margin," Ryan says. "But if Portuguese or Spanish bond yields have gone up through the roof and property yields aren't quite that high, how do you interpret that?" Many real estate investors require a margin on top of the risk-free rate, but because this is not achievable are staying away from the market, Ryan says.

The other point of view he sees, which is somewhat contradictory to the first, is that owning real estate in a country like Spain is safer than holding sovereign debt. "They say, if I take a long lease in a country where the sovereign debt has currently trebled, but I like the long-term look of that economy, I feel I am more likely to get my money back, Ryan says. "If the debt restructures, I might get less than 100% back. But if I buy the building at least I get the building back, and if inflation takes off I have more chance of matching or beating it."