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European Real Estate Equity: Uncovering Value City by City

September 2019 - 8 min read

Charles Weeks, Head of Real Estate Equity for Europe and Asia Pacific, discusses the backdrop for European real estate markets, where the team is seeing the most value by sector and geography, and why they always take an active approach across strategies and investment styles.

As investors hear rumblings of a coming recession, and wonder how to navigate markets at this point in the credit cycle, what is your view on the overall backdrop for European real estate?

I would certainly say that we are in the latter stages of an extended real estate cycle, which has now been going on for over 10 years—due in part to the quantitative easing and low interest rates of the previous decade. But despite the headwinds we’re facing—ranging from global trade and political uncertainty to weakening economic sentiment—the markets are still fairly well supported from a fundamental perspective, bolstered by an increasingly dovish ECB and Bank of England. Generally speaking, we’ve seen resilience in labor markets—particularly in the service sector—and real wages are rising for the first time in a decade, which bodes well in terms of sustaining domestic consumption. Additionally, leverage remains in reasonable territory. While Eurozone growth has been fairly modest, around 1.2%, property prices offer significant relative value to other assets—and we are seeing strong inflows of capital to European real estate, which should support markets going forward across multiple sectors and styles.

Within European real estate, can you explain the various attachment points across the risk-return spectrum? At what stage does Barings invest?

The most stable assets—or bond-like assets, from an income perspective—are core and core-plus investments. These generally have strong covenants with long leases, and they tend to be located in the largest, most liquid markets—which means the yields are typically modest, but so are the risks. The target returns are often in the 6–7% range—about two-thirds current income and one-third capital appreciation—and have relatively low leverage, maxing out at about 30% loan-to-value (LTV). 

Value-add investments often involve acquiring well located but capital starved, under-managed assets—often with impending heavy vacancies—with the intention of fixing them and selling them to core investors. They could also include a forward funding—where you’re essentially buying an asset that’s still under construction, with strong conviction that the completed building will be leased up quickly—while the developer retains the development risk in terms of timing and cost overruns. Target returns for value-add are higher, in the 10–12% range— with a significant portion coming from capital growth, rather than current income—and they tend to have a LTV up to about 60%.  In that respect, it’s more of a capital value play than an income play.

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