Despite the ability to raise public capital, REITs have yet to dominate European real estate. Robert Stassen reports
Real estate investment trusts (REITs) in Europe are not as established as they are in the Americas or Asia. Despite benefiting from better access to various sources of capital and greater transparency, REITs have not gained significant market share in Europe after the crisis. Whether this will change depends on some of Europe’s peculiarities, but also on the continued globalisation of real estate investment markets, which has taken place in global gateway cities such as London and Paris. However, as with many European challenges, events in Germany are a key factor.
Of the total value of commercial real estate in Europe, European REITs own approximately 13%, according to the European Public Real Estate Association (EPRA). In 2012, REITs as an investor class recorded only an 8% purchaser market share in direct real estate investment in Europe, according to Jones Lang LaSalle. This compares unfavourably with the near-18% recorded in Asia Pacific and the Americas in the same period.
The first explanation for this difference is that the REIT regimes are relatively new in Europe’s three major markets – the UK, Germany and France – which together accounted for over 65% of the total European investment volumes in 2012. Although listed property companies existed before the introduction of REITs, France adopted its SIIQ regime only in 2003, while REITs in the UK and G-REITs in Germany were both established in 2007.
In France, REITs have accounted for almost 14% of direct real estate investment over five years from Q2 2008 to Q1 2013, while the UK REITs reported close to 10%. In Germany, the REITs’ purchaser market share was even lower at 7%.
The German figure has been inflated by some large, one-off transactions by foreign REITs, including Unibail-Rodamco’s acquisition of assets from Management Für Immobilien and Corio’s acquisition of a portfolio from Multi Corporation. Domestic REITs (using the wider EPRA definition, excluding residential) only accounted for 2% of investment activity over this time. This is perhaps unsurprising as EPRA estimates that REITs own just 1% of total assets in Germany.
Another reason for the weaker REITs sector in comparison with the US particularly is that Europe is not yet one market. Not only is there no continent-wide euro-REIT regime, capital markets also remain relatively domestic with limited cross-border activity. Consequently, REITs are only able to access capital markets that are much smaller in scale compared with the US, and this removes one of the competitive advantages that REITs have elsewhere – excellent access to multiple equity and debt capital sources.
With so many different countries and legal regimes, it should not be a surprise that combined domestic REITs and sub-regional REITS, which invest in a country cluster, such as the Nordics or Benelux, have been the dominant purchaser group over the last five years within the REITs sector.
Global REITs, which invest in more than one global region, defined as Europe, Asia Pacific and the Americas, account for 11% of REIT activity in Europe. Their focus tends to be on the more global real estate segments of hotels, logistics and large shopping centres, while the European REITs are predominantly found in retail. The biggest domestic REITs are the office focused REITs in Europe’s largest markets, London and Paris.
As offices represent the largest real estate investment sector in Europe, this also has a negative impact on REITs’ overall market share, because, in this competitive segment, REITs only accounted for 6% of activity over the last five years. In contrast, within the retail and logistics sectors, their share is much higher underlining the dominant market position of some of the larger REITs.
However, looking only at the purchasing side of standing properties conceals an important element of REIT strategy: refurbishment and (re)development. REITs with their experienced management teams and access to public capital markets should be well placed to enact value-add strategies where assets are repositioned into core product with a stable income stream that can be sold to institutional investors.
Given this strategy, REITs would be expected to account for a greater share of sales than purchases; over the last five years in Europe, REITs reported a 9% share of purchases but a 12% share of sales. This is particularly true in the large markets of London and Paris where REITs are important developers, but far less so in Germany.
As figure 6 shows, REITs have been significant net sellers since 2008 and, in our view, much of this has been balance-sheet restructuring. In addition, the global appetite for prime product meant that pricing became too competitive for the REITs sector, which is expected to offer higher returns. That said, several of the strongest REITs did become net buyers by 2011 only to see the ongoing euro-zone crisis strip away confidence again.
The view that REITS have been balance-sheet restructuring is reinforced by the use of rights issues by some REITs to restore balance sheets and reduce leverage ratios. Since 2010, REITs in continental Europe have raised nearly €5bn of equity, with capital raising in 2012 up significantly on previous years. Moreover, further activity is expected in Europe with both Deutsche Annington and Cerberus rumoured to be moving forward with initial public offerings. Turning to the UK, 2009 is skewed by the fact that UK REITs were forced to issue equity to bring their loan-to-values down to manageable levels.
While equity raising tailed off thereafter, 2013 has had a good start with close to €1bn raised by April, which is attributable almost entirely to British Land and Intu.
Looking only at the top five REITs in Europe, we see a slightly different pattern of activity in comparison with the overall REIT sector; since 2011 these REITs have been more or less neutral net buyers/sellers. We suspect that these REITs are using finance from asset recycling and issuance of cheaper corporate bonds to continue to develop, taking advantage of the lower levels of competition due to the lack of development finance.
With sentiment improving throughout 2013, better availability of debt and most REITs trading above net asset value, we could see REITs going to the public equity markets to further fund development pipelines and more value-add acquisitions.
Analysis of our European transaction database has shown that REITs are smaller as a sector in Europe than is the case in the Americas and Asia Pacific. However, we believe there is upside potential for the REITs to increase their footprint in the European direct real estate investment market. For example, there is scope for further consolidation in the sector. And if the European Union would create a common REIT structure, this would encourage the creation of larger pan-European REITs.
As transparency has become more important in the global real estate industry, it is no surprise that we have seen an increasing number of non-European REITs entering Europe, such as Brookfield and Dundee International. The potential of this sector is becoming evident.
Robert Stassen is a director and head of European capital markets research at Jones Lang LaSalle