PENSION FUNDS EYE EUROPE AND DEBT RISES TO BOOST RETURNS

• Institutions could move US$400 billion into real estate over the next 3-5 years to diversify holdings and stabilise returns
• Investors to use more debt, but take less risk
• Europe number one target for US private equity; London, Paris remain strong
• Prague among top 20 targeted European cities for overseas investors

Prague, January 6, 2016 – More than half of investors plan to increase real estate allocations within multi-asset portfolios, according to a major new report by Colliers International.

“Our global analysis in this report gives a unique macro-view, providing a comprehensive look at the health of the economy as well as in-depth views of market sentiment that serve as a useful bellwether for local markets worldwide,” said John B. Friedrichsen, Chief Financial Officer, Colliers International. “Our report suggests that the days of ‘pass the parcel’ are over, and long term secure investment in core markets will be the norm. At the other end of the risk spectrum, large volumes of capital already raised will increasingly seek out opportunities in tier-two cities and recovering markets,” he added.

Yields are likely to compress further with 52 percent of respondents to the firm’s Global Investor Outlook (GIO) for 2016 survey saying they would move more money into real estate next year. Combined with relatively low levels of debt - compared with the previous market peaks - this flood of capital would further cement a long-term climate of stability for global real estate returns.  

The GIO for 2016 found that despite a reduced appetite for risk, debt would play a greater role in the market next year as investors seek to boost cash-on-cash returns. 

Colliers, a NASDAQ-listed global property company, estimates that up to US$400 billion of institutional funding could begin chasing global real estate to diversify and stop an ongoing bleed of cash driven by the underperformance of traditional fixed-income investments.

Last month, Japan’s Government Pension Investment Fund posted huge losses and announced a move into commercial real estate for the first time with an estimated US$65 billion of firepower. Chinese insurance companies have already snapped up a swathe of billion dollar assets and could have in excess of US$70 billion to spend.

Such investors demand high value assets so they can deploy large amounts of capital in one go. This is why big cities such as London and New York have become such hot markets with yields crunching well below four percent on prime office buildings.

Investors top 10 target destinations
US 79%
UK 55%
Germany 51%
Australia 40%
France 34%
Japan 32%
Spain 25%
Singapore 22%
Netherlands 21%
Canada 19%

It is the tip of an iceberg of global equity chasing real estate in what experts have dubbed the ‘great moderation’. This on account of the usual boom and bust property cycle being elongated by widespread deleveraging, a far greater reliance on equity and a wholesale re-appraisal of returns.

The GIO found that three-quarters (75 percent) of UK-based investors would use debt compared with 65 percent in 2013. Similarly, 87 percent of US investors would use debt, up from 63 percent in 2013. 

Real estate capital has never been more mobile. At circa US$250 billion, global cross border investment accounted for 40 percent of total direct volumes in the first nine months of 2015. This compares with 33 percent last year, and 37 percent at the peak of the previous cycle (2007). 

CEE

Contrary to some investors’ perceptions, volumes in Central and Eastern Europe (CEE) are higher than they were last year (up 9 percent) and the region is attracting more interest from capital moving up the risk curve and chasing yield. In terms of percentage of the total overseas investors who will invest in EMEA in the next twelve months, of the major CEE cities, the primary targets are Warsaw (6 percent), Prague (3 percent), and Budapest (2 percent).

Benchmark yields in CEE are likely to be achieved in the final quarter of 2015 and early 2016 with core markets achieving sub-6 percent for quality offices and sub-4 percent for prime retail. Modern distribution centers are also moving towards sub-6 percent, but still represent a discount to the best western European logistics pricing. 

In CEE and across the rest of Europe, growing competition has led to an increase in value-add
funds during 2015. These vehicles are often looking to partner with local asset managers to help de-risk the process and the focus has been on retail and logistics portfolios rather than single assets.

Debt coming back to support returns

Price rises and subsequent yield compression across prime property markets mean that taking on more debt is a more prevalent way to achieve some of the lofty returns targets investors have set. By far the most ambitious are US-based investors of whom 40 percent seek internal rate of returns (IRRs) - which essentially measure the return on cash - above 16 percent. It is expected that 63 percent of them will use leverage in excess of 51 percent.

The majority of UK investors are targeting leveraged IRRs of between 11 percent and 15 percent.

In the year to 7 December the FTSE-100 fell by 7.7 percent, while the S&P500 was unchanged. Five-year US Treasury bonds trading at around 1.6 percent.


View the 2016 Global Investor Outlook Report 

2016 Global Investor Outlook Website