Value-Add Real Estate: A European market transformed

Value-add real estate funds have been in vogue recently. In January, when European real estate association INREV released its annual investment intentions survey, it showed that institutional investors have been favouring value-add strategies over core strategies.

As the COVID-19 fallout steers Europe towards a recession, real estate investors are likely to reassess riskier strategies. In March, when the coronavirus hit Europe, UBS Asset Management published a global real estate report. One finding for Europe was that core investments are likely to perform better than value-add strategies in the near future.

“Core is likely to be less affected than value strategies as investment underwritings need to be reviewed,” the report says. “The yield spread between core and value-add assets has hardly been existent in many office markets.”

Gunnar Herm, head of research and strategy for Europe at UBS AM Real Estate & Private Markets, told IPE Real Assets: “I would expect that core strategies are likely to perform better at least for the next year or two… than riskier strategies.”

Paul Jayasingha, senior director at investment consultancy Willis Towers Watson, says that what has made European value-add real estate funds attractive to investors is a 12-14% expected level of return. They have also been attractive in Europe due to lower interest rates compared with the US.

Jayasingha says that what would drive investment in the medium term would be a swift resolution of the COVID-19 pandemic, government actions and a fully functioning debt market. An improved European economy and real estate sector like an improvement in retail will boost investor confidence. In the meantime, value-add fund managers find themselves at various stages of capital deployment and fundraising.

Didde Maria Kristensen, head of investor relations at Nordics property investor NREP, which is seeking to raise €1.25bn for its latest value-add fund, says COVID-19 will certainly be a “short-term challenge, but macro trends and demographics will deliver strong defensive protection to our strategies. Further to this, we expect that our investment position will allow us to identify and act on attractive opportunities within our target investment strategies throughout and after the current situation.”

Two of the first investments in the Nordic Strategies Fund (NSF) IV fund are forward purchases of affordable multifamily rentals in Tingbjerg, a low-income neighbourhood in Copenhagen.

The first vintage of the NSF series was set up in 2014 as a step to combine all of NREP’s investment strategies in one vehicle instead of in segment-specific investment funds.

Kristensen says 90% of NSF’s investments are made within the living, care and logistics real estate segment. “This way, NREP has built a robust portfolio benefiting from structural tailwind and solid long-term income protection and based on NREP’s strong development and operational capabilities,” she adds.

Kristensen says the NSF IV fundraise “runs as planned, and with the current interest – also after the COVID-19 outbreak – we’re comfortable to reach the target of €1.25bn”.

Another fund manager identifying the challenges the pandemic brings is Europa Capital. Partner Jason Oram says COVID-19 will have a significant impact on all types of real estate investment in the year ahead as “liquidity requirements may necessitate the sale of assets and impact letting activity”.

He says: “On a positive note, there remains a healthy level of uninvested, committed capital within the private-equity real-estate industry that will provide an important level of liquidity to support the real estate market going forward. The possible concern is that much of that capital will be held within funds that have undertaken significant levels of investment pre-COVID-19. Not only will this require management focus and possibly impact the overall performance of particular funds, it may also affect the confidence with which those funds are able to undertake further investments.”

Oram adds: “The quantity of uninvested committed capital held within funds that have undertaken limited or no investments pre-COVID-19 may well be a very small proportion of the overall amount of ‘dry powder’ the industry is hoping will be available, although these funds will be particularly well-placed to provide valuable support to the real estate market once this crisis has passed.”

Oram says that beyond this previously unexpected influence on the markets, Europa expects the medium-term drivers of occupier demand resulting from European urbanisation trends will continue against a backdrop of limited supply, particularly in the office, residential and logistics sectors. “Meeting this occupier demand in the context of a supply-constrained market will continue to underpin value-add investment opportunity, even during a time of increasing economic uncertainty,” he says.

Europa Capital is planning to raise €750m and has a hard cap of €1bn capital for its sixth pan-European value-add real estate fund. The previous fund, Europa Fund V, which raised €716m, completed 16 investments. The majority of these were in the office and residential sectors.

Two investment examples are an 11,710sqm office building in Paris and a three-building, 318-unit residential portfolio in Copenhagen. Oram says they reflect a focus on locations benefiting from urbanisation and demand for office space through job creation, and residential space through household formation. Both markets are characterised by low levels of vacancy in their respective office and residential sectors.

“As a value-add manager we are focused on the delivery of realised returns and so we are always reviewing the opportunity to divest of our assets earlier than originally underwritten and both of these investments were sold at least one year ahead of business plan to enable early distributions to our clients,” he says.

Oram says, what sets the Europa fund series apart from its competitors is that “we focus on the real estate asset and cr eate value through a granular understanding of the importance of an asset within its immediate micro-location – mindful of the macro, but focused on the micro. We deliver a structurally-driven investment strategy that is less dependent on cyclically-driven investment opportunity that may change from one fund to the next. We consider that our consistency of strategy and scale since the [2008] global financial crisis is increasingly unusual in an industry that is ever more focused on scale.”

Hines announced the first closing of Hines European Value Fund 2 (HEVF2) in January, securing €637m of equity commitments in within three months of its launch. Fund manager Paul White says the fund “resonates with investors in current market conditions”, where low growth and interest rates require true hands-on real estate work to create value beyond income returns.

“We bring a different starting point and fundamental toolkit, compared with private-equity or financial-allocator-style value-add sponsors. This, in fact, exceeded 50% of the final €1.25bn fundraising target. The strategy of the fund and the evidence of HEVF really appear to have been compelling to institutional investors. We plan further equity closings through to the first quarter of 2020.” 

Charles Ferguson-Davie, CIO of Moorfield Group, says investors are principally attracted by Moorfield’s investment track record, the manager’s exclusive focus on the UK, and the depth of its knowledge of the London and regional markets. Ferguson-Davie says Moorfield has a record of 24 years in UK value-add investment, and it has invested more than £4bn (€4.3bn), of which £3bn has been realised, generating a 27% internal rate of return.

“We have always been focused on the UK, targeting both traditional and alternative sectors where there are compelling investment fundamentals – for example, whe  re demand is being driven by structural, societal, demographic and technological drivers and where supply is limited,” he says. “Our current focus is on the build-to-rent (and other forms of private residential for rent), student accommodation, senior living, healthcare, logistics and self-storage.”

Ferguson-Davie says Brexit has been affecting the UK real estate market for some time now. Since the referendum vote in 2016, the market has “experienced periods of both investment and occupational volatility and uncertainty”, he says. “At times this has been a benefit to us, as we have been able to take advantage of reduced levels of competition. However, it has also reduced international investment appetite for the UK and so fundraising has been taking longer than it would have otherwise.”

Moorfield is expected to be in a position to start fundraising for Moorfield Real Estate Fund (MREF) V fund in the second half of 2020 as it concludes MREF IV. “We will be closely monitoring the impact of COVID-19 as this will be a key influence over our investment decisions – and no doubt those of our limited partners,” he says. 

“We will also be reliant on the supply of investment opportunities from willing sellers, but we have a range of themes that we are excited by and focused on across the whole of the UK, which means we… should be in a position to deploy the £300m of investment we are targeting for this year.”

Keith Breslauer, managing director of Patron Capital, believes the COVID-19 situation will be a major focus over the next three to six months at a minimum, as companies seek to underpin their investments and protect capital.

Breslauer says the significant disruption in the capital markets will generate opportunities. “At a more macro level, Spain and Portugal will remain growth stories, especially in the residential sector. We will also be focusing on expanding our successful care homes business.”

He says that Patron Capital seeks to earn superior risk-adjusted returns by taking advantage of microcycles and dislocations in western Europe. “Patron’s investments span traditional real estate assets, encompassing commercial, residential, retail, leisure and industrial properties, that may be housed in corporate entities, assets tied up in complex ownership/debt structures, and large residential real estate portfolios.”