Power to your elbow

When the recession hit, investors and real estate experienced a bad break-up. And just like most people in that situation, the investors retreated to their homes, where they drew the shades, refused to answer the phone and probably ate ice cream while watching reruns of Gilmore Girls.

But, eventually, everyone needs to get on with it, and investors are getting to that point. Most might not be ready to give out their phone numbers yet, but they are out mingling and enjoying themselves with their friends. A few of the more resilient ones are even beginning to venture into the dating pool again.

But even those who are craving a social life are playing it safe. It’s no secret that those investors who have begun investing again are focused on core. So much so, in fact, that some in the industry have questioned whether the single-minded focus has increased competition and decreased cap rates to the point where core is actually more risky than value-added or opportunistic strategies, at least on a risk-adjusted basis. Is it possible for investors to realize acceptable returns on assets purchased at premium prices? With cap rates so low, are investors being paid for the risks they are taking, even if most of that risk is simply overpaying for the asset?

The Right Place

Based on the combined results of the INREV Annual Index 2011 and the IPD pan-European Property Fund Index 2011, it would seem that no-one needs to worry about core-loving investors. According to the INREV Annual Index 2011, core funds returned 4.4 percent, while value-added funds only managed to post a 1.1 percent total return and closed-end funds (generally the type of structure used for opportunistic strategies) returned 2.8 percent.

Even if the added competition for core assets is driving prices higher than some in the industry feel is justified, given occupier demand, the ability of core funds to generate returns four times those of value-added funds would seem to give investors a lot of leeway when it comes to pricing.

The focus on core is totally understandable. First of all, core makes up about 80 percent of the institutional universe, so it is simply too big to ignore. But it might also be the best risk-adjusted investment, even in good times.

At the 2012 INREV Annual Conference in Vienna, Jeff Jacobson, global CEO at LaSalle Investment Management, presented facts and figures showing that core real estate has earned a solid place in a multi-asset portfolio, but that the jury is still out on value-added and opportunistic strategies.

In fact, he posited that real estate portfolios probably should not have permanent allocations to opportunistic strategies because, by definition, opportunistic capital should be flowing to wherever the opportunities are at a particular point in an economic cycle or geographic area, and that won’t always be in real estate.

Jacobson isn’t the only one evaluating how we’ve looked at real estate in the past. Others are struggling with developing structures that pay managers based on performance. Older models pretty much paid the managers based on strategy, which meant that investors were actually paying for risk, not returns. Granted, the idea is that more risk will generate higher returns, but all the investor is really paying for is guaranteed risk in the hope of higher returns.

It would seem to make more sense to pay for absolute returns — if a strategy returns 15 percent, no matter whether it is core, value-added or opportunistic, then the manager should be paid the same. I’d even argue that someone who can return 15 percent with a core strategy should be paid more than someone who returns 15 percent using a value-added strategy. Pension funds are fiduciaries and should be encouraging responsible investment.

The Morning After

With all the soul searching over the past couple of years, the industry appears to be reaching a stage of acceptance. It might not be a Goldilocks environment — that implies a happy time — but pulling up the image of the three bears isn’t far off. According to IPD, participants in the 2009 pan-European Property Fund Index webinar underestimated 2010 results. Listeners to the 2010 webinar overestimated 2011 returns. They had expected 2011 returns to be 8.3 percent. Actual returns were 6.6 percent. This year’s participants expect returns for 2012 of between 5 percent and 7.5 percent. Will they be just right?

MIPIM, too, seems to be reaching a stable place. Before the crisis, the huge trade fair had become a cliché of wild all-night parties and frat-boy drinking contests. After the crash, firms drastically cut the number of staff they sent to the event, and those that attended came to work. There are still wonderful receptions, and champagne is always available from morning to night (or next morning), but participants arrive with a purpose and a list of meetings. It’s now viewed as a must-attend event to do business.

At Nice airport on the Friday morning, tired delegates greet each other with, “How was your MIPIM?” From what I heard, the stock answer this year was, “productive.” And that seems to hit just the right note for this market environment — not too optimistic, not too pessimistic. Just right.

Sheila Hopkins is managing director – Europe at Institutional Real Estate, Inc.

Side effects of austerity

The Chinese government has been steadily applying measures to cool China’s property markets, ranging from instructing banks to curtail lending to property market participants, to introducing pilot property taxes in several cities, etc. Although headlines can be quite confusing, it appears these measures have started bringing about results and the prices in many cities have either stopped rising or decreased. Deal volume went down, too.

One of the consequences of these policies is that many developers, especially smaller and poorly capitalized ones, came under pressure as they had difficulties getting bank loans. Some tried to issue bonds and other papers, others borrowed from trusts at considerably higher rates.

Many developers lowered prices trying to clear their inventories, creating friction with buyers who purchased their apartments earlier at higher levels. This situation led many potential buyers to postpone their planned purchases in the hope that prices would continue to decrease. As a result, many developers ended up with a lot of properties not knowing exactly what to do with them.

Most mainland developers pursued a model where they would quickly dispose of the properties they had just finished and move onto a new project. High demand for residential properties supported them well, and many got rich pursing this model. Unlike their counterparts in Hong Kong, most of them never planned on retaining and managing the properties they built. However, under the new “austerity plan,” this started changing.

I recently attended several conferences in China and had an opportunity to learn about new developments among Chinese real estate firms that may have started new trends. From various panel discussions, I learned that many developers started retaining and renting out their properties instead of selling them. If this trend spreads quickly and encompasses a considerable number of developers, it may help to maintain property prices, as the developers will not be under pressure to dispose of their properties quickly at lower prices.

One of the developers on a panel shared his experience and said that what prompted his firm to consider retaining and managing its own properties was the fact that the rents in the office buildings the firm had built and sold doubled within three years. This caught their attention and made them think differently as to how they should manage their business.

One of the positive consequences of this development can be an increase in en-block, as opposed to strata-title, transactions. If a developer retains, fully leases and manages an office building that it builds, then it will have a better chance of selling it later as a stabilized property to an institutional investor en-block, rather than trying to sell it floor-by-floor to many different owners. This will definitely create more institutional-grade properties and will facilitate development of an institutional investor market in China, where currently such properties are in short supply.

Another new trend is the fact that many developers have started putting together property funds with the properties they built and selling shares in these funds to individual investors. If this new business model catches up with retail investors, it may alleviate speculative buying of individual apartments by retail investors as it will give them an investment vehicle in the property sector so popular in China.

It is interesting to observe how government measures originally meant to cool the property market made market participants think strategically and create new business models. These models may or may not survive and prosper in China, but they are very much along the lines of what happened in the mature markets of the United States, Europe and Australia.

Alex Eidlin is managing director – Asia Pacific at Institutional Real Estate, Inc.

Bulls, cubs and toll roads

Most people if given the chance to compare Chicago and Spain might find it easier to think of the differences than the similarities — harsh, cold winters compared with a mild Mediterranean climate; the Cubs at Wrigley Field versus running with the bulls in Pamplona; deep-dish pizza and paella — but one thing the two share in common is leadership in private infrastructure investment.

Spanish firms Cintra and Abertis are two examples of the types of leading global infrastructure developers and managers in the country, and Spain has been a pioneer in private infrastructure investment, development and management, having started in earnest in the late 1960s. Chicago, meanwhile, is one of the United States’ private infrastructure investment and development capital swith several recent marquee transactions. Bringing together the experience of these two leaders May 3 for The Value of Public-Private Partnerships event — hosted by Chicago-based law firm Baker & McKenzie, the Spanish Trade Commission and the Spanish Institute of Foreign Trade — made for an interesting and insightful mix of perspectives and opinions.

The perspective and opinion many wanted to hear the most was that of Lois Scott, CFO of Chicago and head of the city’s newly minted Chicago Infrastructure Trust (CIT), which aims to leverage private capital to invest in city infrastructure.

“We can’t get lazy as an industry,” Scott told the 100 or so attendees. “P3 needs to move to the next era — an era of accountability and transparency.”

The Chicago City Council had, a little more than a week earlier, approved the establishment of the CIT to provide funding and credit to projects, and according to Scott, the CIT could not get started soon enough: “We are literally throwing tax dollars out of windows because in the past we have not packaged these projects correctly,” she said in describing the CIT’s first expected project — a $225 million city building retrofit whose goals are to reduce energy consumption and create jobs.

Another theme of the event was working with and understanding the needs of all stakeholders involved in a public-private partnership. “We have to do a better job of getting all the stakeholders on board and getting them to understand the risks,” said Michael Lapolla, managing director with Global Via USA. “Allocating risks means different things to different people.”

Something that may seem relatively simple to some people involved in a P3 project, for example, how to price a fixed contract, “is not something [big construction firms] are used to,” Lapolla continued. “We work with truckers and shippers to educate them on the process and get buy-in. You need to get all the stakeholders in a room and talk about the risks.”

One of the main takeaways from the event was the need for leaders and leadership to continue to move private investment in infrastructure forward and work through and manage the risks as more projects are funded with private capital. And for this, there was no better place to be than at a meeting with private infrastructure investment experts from Chicago and Spain.

Drew Campbell is senior editor of Institutional Investment in Infrastructure.