A sea change from across the Atlantic?

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North America is leading the way once again, with the exceptional communicator and statesman Barack Obama safely installed in the hot seat for a second term.

Having led (i.e. caused!) the credit crunch, the US is making the most of its relative safe haven advantage and utilising the depth and diversity of its funding markets to great effect. This in turn has provided good real estate investors with more funding options through corporate bond issuances, plus loans from insurance companies as well as banks. DTZ boldly stated last autumn that, as a result, there was no funding gap in the US. In consequence, acquisitive US Private Equity funds such as Blackstone have begun mopping up bargains all over the world. Over the last year, domestic unemployment has decreased from 8.3% in January to 7.7%, homebuilder sentiment has risen to its highest level since 2006, and prices are up by about 17%.

Just as significantly, DTZ also said they expected the UK’s real estate funding gap to be all but eliminated by 2014, with equivalent funding lines to those active in the US recently tested and expected to expand significantly in the months ahead.

In the Eurozone, meanwhile, DTZ expect the funding gap to remain outstanding for some years. Even so, it looks promising that the crisis is taking a course “less bad” than most had expected  -much to the credit of (ex-Goldman Sachs) Mario Draghi, President of the European Central Bank and FT Person of the Year 2012. Draghi’s promise to “do whatever it takes” seems to be working.

As a result, the recovery of Greek Bonds has proven to be the hedge fund play of 2012. And if the Spanish government finally requested a Euro bailout, the country’s banks only required half the expected £100bn. The great exception of course is France, where policy makers seem to be doing their utmost to dismantle the economy (to the benefit of London). Economic disaster looks increasingly likely as wealth creators jump ship before they are pushed or even have their ships confiscated (as with Arcelor Mittal)!

Returning to the outlook for the UK, Mike Carney (notably also ex-Goldman Sachs) has been recruited as the new Governor of the Bank of England. He is widely considered to be one of the top two central bankers in the world, which is quite a coup for George Osbourne. Carney is generally expected to promote higher growth and employment, with interest rates staying lower for longer at the price of higher inflation.

This should be good news for investors like Inspired who concentrate on “real assets”, as values and incomes increase while debt as a proportion of value diminishes.

It is likely to encourage greater risk taking by investors who need to find higher returns in order to protect their capital, which will be at greater risk of erosion from inflation – currently standing at 2.7% and remaining stubbornly above the 2% target. Again, this represents good news for opportunistic investors like us: competition for assets may make it harder to buy cheaply, but there should still be plenty to go around as the US funds that bought loans in 2012 take action and make their margin by offloading in 2013. Additionally, our existing assets are all located in Inner London and should benefit from an increase in value, while capital should become easier and cheaper to raise.

I firmly believe that more risk taking (within reason) is a good thing generally: fear has a corrosive rippling effect through morale and into trust, investment and employment and has in itself become the greatest threat to our future wellbeing and prosperity. A more confident approach, as we’re beginning to see in the US, may just offer the perfect antidote.


Smiles all around

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Star JP Morgan real estate analyst Harm Meijer and his team recently published their 2013 forecasts – and they made for very encouraging reading.

The key message underlined the strong capital flows into markets and the belief that we are entering bubble territory for prime real estate in core Western European countries, which will prompt investors to move up the risk curve and invest in secondary assets.
Experienced management teams will be able to raise capital cheaply. To illustrate the point, almost 90% of listed property management teams (as surveyed by JP Morgan) expect capital raisings in the sector over the coming months.

The report also specifically highlighted London in stating:

“The ‘London is booming theme’ will carry on next year and we expect John Burns, CEO of Derwent London, to say at our conference in January again: ‘I can’t say it is bad, when it is good’.”

Shaftesbury too recently affirmed that London is more vibrant than ever.

“And we agree with that. The interest rate for London itself is too low. Valuations will rise further, but we believe there will be more talk about property values, after those have further surprised on the upside, and the coming residential boom in 2013.”

That sounds good to me and we share the sentiment.


Inspired is delighted to have acquired 19 sites during 2012. These will ultimately produce some 84 units of mostly residential accommodation in Inner London (typically Zone 2) locations and will be worth a total in excess of £20m on completion, with margins on cost typically exceeding 50% and in some cases even 100%+.

Such impressive returns are the result of a bold contrarian approach in a nervous market, not to mention an awful lot of very hard work. We couldn’t have achieved it all without the help of the people we have had the privilege of working with over the past year including friends, family, investors, lenders, professional advisers, and our Inspired team.

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Our objective has always been to establish an efficient business in which we and all our stakeholders would benefit. 2012 was the year we could truly say we succeeded in that aim.

I have absolutely no doubt that we will do even better this year and look forward to working both harder and smarter to achieve the best possible results. After all, it’s not really work when you’re having so much fun, is it?!

Notes from the Ernst & Young (E&Y) EMEIA Real Estate Workshop in London


Worrying backdrop:

  • Massively increasing debt in the UK (£1tn) Europe (€8tn) and the US ($15tn).
  • Political dysfunction in both Europe and the US.
  • Substantially increased regulation including Basel III and Solvency II which are set to further reduce the financial sectors capability to fund growth.

If Europe completed the same degree of quantitative easing as the US has then they would be able to buy some $1.3tn of assets which is thought to be likely to be enough to staunch the crisis.

Michael Portillo:

Described himself as an ex future Prime Minister turned entertainer.  He made an excellent speech in particular highlighting the reasons the Chinese gave for not investing in the European bailout namely stating that that it was because the welfare state was wholly inappropriate.  “The welfare system should not be structured to encourage sloth and indolence”.

This highlights the trend towards growth in the East (Asia) & South (South America) and extended slowdown in more mature markets in particular in Europe.

Interesting aside when the Greeks borrowed in their local currency (drachma) they paid 25% interest rates whereas they paid closer to 1% after adopting the Euro.  With that in mind you can understand why they are keen to stay and also how they got themselves into too much debt after joining.

Even though many of the troubled Southern European nations have made great improvements to their fiscal positions they are not emerging from the crisis.  The overriding issue is that many are stuck with inappropriate exchange rates as a result of their tie into the single currency.

Whatever is said about the likes of the Greeks own culpability the human cost has become very high with aid agencies that typically operate in places like Uganda now to be found working actively to help people in places like Athens.

Policymakers should consider all the possible outcomes and, in particularly difficult cases like the ‘bleeding stump’ Greece currency presents, look for the least bad option.  One major problem to-date has been European leaders have called a break up for the weakest economies ‘unthinkable’ which means they probably haven’t thought about properly yet.

In the UK Portillo believes the government effectively has a policy of shrinking the public sector to make way for the public sector.  He suggested we think of it like a great big tree casting a shadow over the private economy.  [MS: I agree, the state should step back and reduce its interference so that entrepreneurs can enjoy fuelling real growth again.  And I believe we’re very lucky that in this country we’re moving in this direction.  It should give us an improved competitive position in the years ahead.]

The austerity measures are critical for us because we need to maintain low interest rates on govt debt and markets can move against us extremely quickly if they don’t continue to display strong fiscal competence and consistency.  The deficit is fine if you can finance it at present rates of interest.  If not it becomes a very vulnerable position to be.

Opportunities we in the UK are taking advantage of include devaluing the currency and effectively printing money.  This raises the spectre of inflation which most governments are in favour of at present because it’s the easy way to deflate sovereign debt.

Government is following the Thatcher strategy of not trying to win a popularity contest rather it is simply trying to make the right decisions which it hopes to be recognised for later on.

Opportunity Funds Panel (inc BNP Paribas, Pramerica, Tristan Capital Partners & E&Y):

Audience votes generally in favour of opportunity funds buying real estate now.  Expected to be more of a medium term grind suited to stock pickers than a general gold rush.

A shrinking capital market is still expected over all with the number of managers set to halve in the next few years.

Fundamental gap between returns from  enforcement and restructuring (nominally estimated at 70% of face value of loan returned) compared with the return from a sale to an opportunity investor (nominally estimated at 50% of face value once current asset value discounted to allow for 20%pa return).  This has limited bank disposals to the wall of advisors and investors who are continually offering their help with problem loans and assets.

Bank deleveraging to meet Basel III is the equivalent of squeezing an 8 year business plan into 8 months and the total value of this is estimated at between £1-3tn.  This is likely to be focussed on low hanging, dollar denominated, fruit.

The bid ask gap hasn’t narrowed sufficiently yet for the volume of trades to increase significantly and it’s therefore still very difficult and taking a long time to close deals.

Proceed with caution.  There are and will continue to be miss-priced assets out there for those with the skill and determination to find them.

There is a sense that the best deals are in the c-grade market but that investors will ‘practically throw up all over you’ if you recommend even secondary.  Hence it’s going to be difficult to deploy substantial volumes of capital but there is money to be made.

REITs (Real Estate Investment Trusts):

Changes are underway to the REIT market in the UK in particular to encourage the creation of residential REITs.  E&Y thinks more needs to be done to facilitate significant activity here though.  In particular the trading rule needs to be allowed because residential investors tend to trade a proportion of their stock to boost yields and currently the tax implications of this are prohibitive within the REIT structure.

Strong investment & market case for the creation of mortgage REITs.

Institutional Investor Panel (inc Canada Pension Plan, Oxford Properties, Allianz & Orchard Street):

Appetite shown for increasing the allocation to real estate but cautionary comments made around some of the challenges involved.

No rush to deploy capital seemed to be the general attitude with some tentative signs of an increase in suitable deal flow.

Allianz explains that insurance companies account for 30% of the RE lending market in the US but far less in Europe.  This is probably because the margins were twice as high in the US as compared with Europe so with margins on European Real Estate loans having now increased the insurance sectors’ exposure to the lending market should steadily increase.  LTV’s around 60% and 7-10 year terms are typical.

The panel appears expects to be relatively unaffected by Solvency II because in the case of pension funds and insurance companies they have very high capital adequacy ratios already.

Real Estate Funds: Strategic Options Panel (all E&Y):

Extending again is becoming a less convincing proposition to incumbent lenders.  This should lead to some additional transactions (not a flood).

Fund raising:

  • 440 funds chasing £151bn of equity (3 times the amount raised in 2010) – so basically there are too many funds chasing too little equity.
  • Simplified fee model desired – single fee model clearly preferred over multiple transaction-related fees.
  • Sector specific funds (by geography & asset class) preferred
  • Funds focussing on fewer ‘like minded’ investors
  • Funds are raising around $50bn a quarter which is the 2004 level.  By around 2014 this should have picked up quite a bit and investment globalisation should have returned.

Future trends:

  • Uncertainty – a little bit more of more of the same
  • Maturing debt
  • More HNWI investments

The pro-Europe team (Internos, Westbrook) won the Industry Debate against the pro-Emerging Markets team (E&Y).  The transparency & security arguments proved persuasive despite all parties seeming to agree Europe was effectively bankrupt and the expectation that Emerging Markets would grow a lot faster in the years ahead.

Always look on the bright side of life

By Martin Skinner,

"Martin Skinner"

Martin Skinner

The last few weeks have been frantically busy and while lots of big deals are on the horizon, fundraising and transaction setbacks are still frequent and frustrating.

On the personal front I’ve just returned from a trip to New Zealand and best man duties at a close friend’s wedding.  In fact I wrote most of this on the long flight back, having written my speech at the last minute on the way over.  The big day was fabulous and was followed by a tour of the North Island together with Ben and Anna the newlyweds, their daughter Trilby (hats off to them for that name) and Ben’s family.  Some honeymoon! I was there when we heard the terrible news from the South Island and my heart goes out to everyone in Christchurch.

Ben & Anna take their vows led by Captain Barnaby

Ben & Anna's Wedding in New Zealand

While I was out there corrupt leaders were falling like dominoes as people harnessed the power of everyday web tools like Google, Facebook and Twitter.  The debate rages as to whether the situation will deteriorate without the ‘regional stability’ these leaders used to provide.  Personally I believe increased transparency and accountability will lead to better government in the long run and that must be a good thing.  Short to medium term the instability will increase the flow of capital out of regions like the Middle East and into safer environments such as prime and fringe prime London property.

In terms of the UK economy, discussion is finally turning towards growth. While the downside surely has to include rising interest rates, there is also much to be positive about.  David Smith recently published another superb piece describing how the ‘feel good factor’ was lost when consumer price inflation overtook wage inflation, an event that paradoxically contributed to higher employment and lower interest rates.  He also highlighted a report forecasting a return of the feel good factor next year, when broad inflation is expected to fall back below wage inflation once more.  At the same time, development luminary Mike Slade listed many more reasons to look on the bright side of property life in his recent Property Week article.

I’m sometimes accused of being optimistic as if that’s a bad thing.  Yes, I underestimated the credit crunch and agree it’s important not to get too carried away with wishful thinking.  At the same time, it’s also important to recognise the positive signs that are beginning to appear.  When I was playing a lot of tennis, we were always told to focus on where we wanted to hit the ball and it clearly improved results.  With timing and location critical to success in the property market too, I’m looking forward to some excellent years and returns ahead – particularly for investors in London residential.  As real estate emerges from the downturn, London’s diverse, much vaunted and ultimately proven strengths will continue to draw both investment and human capital in ever greater numbers.

Having just gone through a recent batch of reports from the big UK residential agencies, I thought the following key points and charts on London residential property were worth sharing:

“…an astounding 70% [or £2.9 trillion of the £4.1 trillion total market value of UK residential property] is held as equity”.

“…it is London’s status as a world city that sets it apart in value terms from the rest of the country.” Yolande Barnes, Savills, Residential Property Focus Q1 2011
Savills are now forecasting a rise of 33.4% in prime central London house prices over the next 5 years.  See the full report here.

How low levels of available housing stock have historically supported house prices

Available Stock vs Price Growth | Savills

“Outperforming their national markets, the cities of London, New York, Moscow and Hong Kong are sought after by the world’s richest households and are at the forefront of a truly global market ~ the residential sectors of these global cities have more in common with each other than they do their domestic markets” Yolande Barnes, Savills, Spotlight on Four Global Cities, Feb 2011  Read the full report here.

5 year performance, cities (executive unit) versus countries (national house price index)

5 Year City Performance | Savills

“Global economic growth is now running at pre-recession levels contributing to wealth creation around the world which is pouring into London again. ~ London’s reputation as a ‘safe-haven’ investment location, combined with geo-political concerns elsewhere around the world, most recently for example in Egypt and Tunisia [and now Libya], have helped draw buyers into the market”  Liam Bailey, Knight Frank, The world’s most desirable residential market: The Super-Prime London Report 2011

P.S. Check out www.beek.co This is recently married Ben Knill’s new and innovative technology venture and it’s shaping up to be a huge success!  I’m proud to say that we incorporated early versions of his interactive 3D walkthroughs on our consumer website Nice Room as early as 2003.  Prospective tenants loved it and we got a lot of remote bookings as a result.  As consumers increasingly shop online and seek comfort in online research before buying or travelling, its potential is enormous.

Notes from the Ernst and Young EMEIA Real Estate Workshop

Ernst & Young EMEIA Real Estate Workshop

Here are my notes from the excellent E&Y Workshop I attended recently.

Bid-ask spreads narrowing
Transaction levels rising

Sir John Gieve (former Deputy Governor of the BOE)
The uncertainty is still there because:
Economic forecasting models are broken
Prediction: big swings in market sentiment & lots of volatility in the markets Currently fiscal (spending) and macro-prudential (regulation) brakes on while the monetary (interest rates, QE) accelerator is firmly on Expectation that private sector investment, consumer spending and emerging market growth will pull the UK towards around 2% GDP growth in 2011 MPC likely to be cautious about raising rates early in 2011 but if growth continues throughout the year then rates could rise faster than the market currently expects (to somewhere between 3-7%) Emerging market economies in particular the Chinese likely to lead to a big inflationary boom that spreads to the West through commodity prices

Adrian Cooper (CEO, Oxford Economics & ITEM club advisor)
World GDP growth is outstripping already relatively bullish forecasts North and South Europe dramatic divergence in growth and prospects German competitiveness has improved significantly over last 10 years whereas southern European states have become significantly les competitive as labour costs have risen Fiscal tightening and divergence in investment will also hold back the Southern economies for a prolonged period c50% chance of Greek debt restructuring and/or smaller chance of some form of Eurozone breakup Other notable risks include oil and commodity inflation and recognition of Spanish debt/losses as a result of their boom time lending to construction In the UK massive switch in govt spending worth around -1% on annual GDP growth Household de-leveraging to hold back growth further Rising exports will help though past failings in exports to emerging economies (Italy exporting more to the BRICS than the UK for example) Modest growth forecast in office-based employment and consumer spending leading to limited demand growth in offices and retail property High single-digit total returns expected for prime commercial property

Macro-Economic Panel
Huge demand from the Middle East for construction and infrastructure but there are major risks around political risks as a result of underinvestment in food, healthcare, education, employment and social stability.
If we can see civil unrest in the UK then we can expect to see unrest in other states as austerity measures start to bite.
US deficit is not expected to be a major threat in the next couple of years but it will be in the longer term – the UK had the same problem when it ran the reserve currency and that held us back for 50 years after the second world war Currency disparities and interventions make life difficult for global Investors seeking to hedge out risks Pension funds slowly increasing allocations to real estate but notably focussing on core assets and focussing increasingly on specific cities rather than whole countries Negative real interest rates could lead to a bubble in some asset values.  Highly leveraged investors even in core assets are at risk from interest rate rises designed to combat high inflation Euro stress tests back in July showed 84 out of 91 banks were well capitalised including the 2 largest Irish banks which are now bailed out.  This will prove a drag on the economic recovery and it will take quite a long time to relieve c50% of maturing real estate debt is underwater and although resulting opportunities are few and far between they are worth looking for

Drivers of Real Estate Panel
Property looks more interesting than bonds but less attractive than equities (Harm Meijer, JPM) Lots of inflows to direct investment funds moving out of bonds (Harm Meijer) JPM are positive on property, more prime but starting to find opportunities in secondary Institutions are currently underweight in property and increasing their allocations.  Increased inflation driving this demand as they look to protect themselves.  Harm Meijer is astonished that they are coming so late to the party Trust issues will endure for years ahead while funds re-align their interests with LP’s and increased co-investments are demanded UK retail funds raised a lot of money in Q1 2010 and 2007 opportunity funds are all sitting on a lot of cash but is there a bubble in prime and super-prime and do return expectations need to come down.
“If you look at what is happening to real estate, it is exactly what happened in 2007 and 2008 when cap rates were plunging and LTV’s were going up without cash flows”. (Starwood Capital Chairman & CEO – Barry Sternlicht) Caveated with in certain prime sectors (Doug Kirkman, Blackstone) It’s probably the best time in living memory to setup a bank because margins are very high and lenders can pick their borrowers and properties.
Existing lenders cannot afford to take the losses on existing loans so they are very limited in their capacity to lend.  Particularly in the UK where there is still no securitisations market in contrast to the US which has begun to close some and is expected to increase this flow.
Insurance companies may increasingly likely to enter the market (Solvency II will encourage them to do so) but it will take them time to build their teams and they are unlikely to buy up existing debt portfolios.
According to Knight Frank 2010 occupier take-up in Financial Services in the UK was actually higher than during the boom years however this is substantially offset due to impending lease expiries and competition from Internet based businesses etc so net absorption and rental growth is likely to be quite limited and generally restricted to prime.
London and Germany are relatively booming whereas regional locations are really struggling.
Supply of product is going to be slow while the clearing prices continue to sit below the holding values and supply of debt is highly restricted and it is likely to take some years before big non-performing loan books really come to market due to political debates around bank break ups etc.
Sustainability – opportunistic investors are less interested in this than price etc however pension funds are pressuring listed owners and occupiers are increasingly expected to demand higher standards.
Increased transaction activity is expected though only by around 10-20% and from a relatively small base.
Banks will have to extend and pretend until deals break and have to be dealt with or they have generated sufficient profits for their capital base to enable them to take losses on existing holdings.