Sticks and carrots

Last year the FT referred to Prupim CEO Martin Moore as Britain's third most powerful property player - after two politicians. He would never tell you that of course! At the helm since 1996, Moore is passionate about sustainability and the need to engage at the highest levels to progress this and other key industry issues. He is also unshaken by today's uncertain times - an opportunity as much as anything, as he explains to Martin Hurst

How do you view the current credit crisis?

I believe it is important to distinguish between what has happened over the last few weeks and what we have seen for many months before that, namely an increasing concern about the irrational exuberance in global real estate markets, the weight of money chasing limited opportunities and the effect that was having on ‘pricing perfection'. The flip side of that is the almost global repricing of risk. By ‘pricing perfection' I mean that the normal underwriting skills and normal attitudes to risk were being put to one side and every possible variable was being assumed to have the best possible outcome and was being aggregated to get to the sort of bids that buyers were making.

We are now in a period of reflection and a reconsideration of risk around the world both for real estate and for other asset classes, although I think in Europe banks will still be willing to lend. Spreads will undoubtedly widen. I think that loan-to-value rates will change as well and people will adopt a more cautious approach. However I don't believe that the market will dry up, although the demand from debt-driven buyers will be clearly far far lower than it has been.

I think it is too early to make a translation of these events into underlying occupier demand, although the gossip on the streets is that most markets will remain largely unaffected. Analysts are a little concerned about the City of London given the
dominance of the investment banks and the financial sector driving demand there.

The current climate and events leading up to it will lead to a repricing of risk - I am very clear about that. There are different markets at different stages in the cycle and different pricing levels. One particular impact will be in the re-emergence of the distinction between prime and secondary. Throughout most of my career there has been a pricing differential but this gap had almost closed.

There will be a re-emergence of the significance of trophy/quality assets, be it driven by investor demand, be it due to less willingness on the part of banks to lend on secondary assets or be it due to the reassessment of risks associated with more secondary assets which, by definition, may be less generative of rental growth. So there will be a re-emergence of pricing polarisation both in the UK and across the rest of Europe. This might be quite significant because so many markets have enjoyed the yield compression phenomenon and we are now going to see a reversal of that as yields begin to ease.

So the impact felt in high quality portfolios will be relatively small compared with portfolios consisting of assets of mediocre quality. But a lot of this is intuition. I expect a wait-and-see approach for the foreseeable future. So even though volumes of activity so far this year have been in line with or ahead of transaction levels last year, the last quarter of this year will see much lower transactional volumes, as people pause for breath to see how the dust is going to settle.

Some people say this has just taken the froth off the market. What do you think?

It has been a hugely challenging market to engage in over recent times because of the number of competitors and the impact of debt-driven buyers. Furthermore the fact that there were €5 chasing every €1 available made it very difficult for rational investors to get their minds around pricing levels and to invest in line with the flows of money coming our way. If things do calm down and we see a resumption of more normal market conditions, the resulting equilibrium will make it a much healthier market for people like us, even though the transition may be bumpy. It will no longer be a case of €5 chasing every €1 but even if the ratio becomes €3 or €2 to €1 that weight of money will ensure that the market does not collapse.

Does the industry not learn from its mistakes?

I think the industry is getting better at learning from its mistakes - if you look back at the correction that occurred in the early 1990s a lot of the drivers were very different: a very laissez-faire planning environment that has since been tightened by government, dramatic oversupply and developers losing control. The City of London was a case in point - huge oversupply, relative to the underlying demand. This is just not a feature today. Markets at that time were far more opaque, far less researched and discussed.

Today the markets are more transparent: performance measurement and the understanding of markets and attributions - the whole science behind property portfolio management is significantly stronger today than it was even 10 years ago.

Today there are new experiences to learn from both in the commercial and residential markets, such as attitudes to risk and the way lending is being conducted.
We will be concerned about the short-term changes and adjustments but we should hold true to our approach and our medium to long-term thinking that the fundamentals haven't changed. We are looking forward to calmer months ahead and will not be unduly distracted by what we consider will be short-term turbulence.

What is the view of investors, particularly those who are experiencing a credit crisis for the first time?

Like us the pension funds will be very active observers of markets which are going through a period of change and correction. And let's not forget that every cloud has a silver lining: from the turbulence will come opportunity. So as much as we are concerned about short-term adjustments, we will at the same time keep one eye on the opportunities that will be presenting themselves around the world.

What happens in the US will be hugely important - how banks react, how lenders react and how occupiers and underlying demand develops.  It is too early to say but for us will it change the direction of travel? It may in some areas accelerate and in some areas slow down but it will not change our overall strategy.

What might the less sophisticated investors learn from the more sophisticated ones?

Among the things we have learned from the US is the way they evaluate investment opportunities. They use much more explicit, much more refined, cash flow-based analyses. We have also observed the US REIT sector where we have seen the emergence of a fairly granular specialisation - Californian nursing home REITs or eastern seaboard hotel REITs, for example, a trend we expect in the UK and Europe over time.

In Europe the work INREV has done, be it in performance measurement or fees or in calculation of net asset values, has helped create a market in unlisted investments that is more transparent than the unlisted market in the US.

In the UK, we were an early mover in engaging with government about the applicability and admissibility of property derivatives. We helped the debate and we have been a major player post approval. It is not often that the UK is ahead of the US in property investing but derivatives is one exceptional example.

The market continues to converge its protocols and understandings. It has become so much more global. Best practice and experiences can be shared in an instant. Differences which we may have seen 10 years ago are now very quickly closing, even in some of the emerging markets in Asia where local real estate market participants are hungry to learn.  

How could others learn from you?

Prupim has devoted much attention to sustainability across all our portfolios. Housebuilders have developed a code for sustainable homes which is a very interesting model. It is voluntary at the moment but the UK government is thinking about making it mandatory. But it is not just about sticks - it is about carrots too! For example, there may be an incentive for those that are developing at the six star level with time-limited abatement of stamp duty and accelerated planning applications.

Housebuilders believe that those developing at a higher level will have a point of distinction in the marketing of the product and there will over time be a willingness on the part of the housebuyer to pay a little more for sustainable features. In the commercial sector the government is engaged in dialogue, the aim being to achieve similar outcomes in the commercial real estate industry to what they have agreed with housebuilders.

In Australia a tipping point in the sustainability debate came when government occupiers said that they would only occupy buildings that met a certain environmental standard. This made developers think differently about the product they were offering.

There will come a time when occupiers in the UK market will say the same thing; as with Australia it may take the government to prompt that attitude shift.

While there is a cost associated with meeting this standard, in the medium to long term there is a cost of not doing so. It is much more difficult to build and then refit to meet sustainability requirements than to build sustainable buildings as new. We believe that over the next five to 10 years a new norm will emerge, and buildings that are not compatible will be discounted.

Beyond new developments, we believe that there is much potential in bringing existing buildings up to higher standards of sustainability. Our ‘Improver Portfolio' is a £500m (€717m) representative sample of commercial property where we are introducing low cost and no cost initiatives to make these buildings more water, waste and energy efficient and to reduce their footprint on the environment. In parallel we are monitoring the portfolio's performance to ascertain how investment returns are affected. Although we are feeling our way on this, it will be a medium-term experience which should inform our own strategy and management approach going forward.

We would rather engage with our stakeholders and be part of this debate than have the government dictate outcomes to us. I am encouraged by the fact that there is an active debate going on with a cross-section of the commercial real estate industry and am confident that, working alongside government, there will be challenging but sensible outcomes.

Our clients are increasingly willing to engage. Two or three years ago sustainability was not on the agenda; now it is a regular feature of debate. Investors are taking a measured approach but are increasingly aware of the issues and opportunities.

What are your views on current levels of governance?

I think this is a hugely challenging area. At Prupim we make it our business to try to engage with legislators. For example, we are very much engaged in the debate which is taking place with the European parliament on ways that regulation can allow easier distribution of locally regulated property funds throughout Europe. We are also trying hard to navigate the country-by-country regulations that govern private placement throughout Europe.

In the UK, work with the Treasury in the area of authorised investment funds and how the tax regime might look is a priority for us and we are also working with government to improve operational standards of commercial landlords. We are working both with UK and continental European governments on many different levels.

What is your view of the service provided by industry associations and the way they work together?

We have a very high regard for INREV, and EPRA is also fulfilling a hugely useful function. But there is a tendency for new associations to emerge with great regularity - some quite mainstream, some quite eclectic. With this comes an increased risk of insufficiently joined-up dialogue with peer group associations, leading to the reinvention of the wheel and consequent resource wastage.

In the UK we have been very keen to promote a joined-up dialogue and have contributed to the creation of the Property Industry Alliance which is an increasingly relevant and important umbrella organisation encompassing the IPF, the BPF and the RICS and the BCO (British Council of Offices) to encourage this more integrated debate and avoid wheel reinvention. The organisations which are represented have different skill sets, so let's play to their respective strengths. The PIA enables us to speak with a more powerful voice than would be possible if we remained more fragmented.

What are your main strategic objectives?

Prupim's main investment focus is on core markets around the world. We have been investing in UK property for over a century and more recently in continental Europe, North America and Asia Pacific markets. Investing in international property markets brings considerable diversification benefits and opportunities to institutional investors and I think this is even more important now as some of the major commercial property markets start to slow. However, we still believe many institutional investors, pensions funds in particular, are still underweight in international property. The real capital growth opportunities now lie internationally and we think many pension funds will take advantage of this diversification opportunity going forward.

One key objective next year will be to significantly grow our Asian business through Prupim Singapore. We were the first to launch an open-ended pan-Asia property fund last December and this has already tripled in size. We also intend to become involved in Vietnam where we can leverage from the very strong local presence of other parts of the Prudential group. But the focus won't just be on Asia-Pacific - we intend to grow and continue to diversify our business throughout Europe and North America as well, to firmly establish ourselves as a truly global player.