Strong capital flows together with the belief markets are entering bubble territory for prime in core Western European countries will prompt real estate investors to move up the risk curve and invest in secondary assets next year, predicts JPMorgan’s real estate analyst team.
“During 2013 investors will increasingly look at secondary property, but that is not because the prospects are so great, but more because prime will be so expensive.”
Meijer argued that as a result JPMorgan is forecasting a deteriorating risk/return profile for the listed European real estate nest year.
“Nevertheless, we see a higher chance that prime will enter bubble territory next year than that secondary real estate will outperform. We know property agents think differently, but we stick with our trade.”
DTZ’s research team has forecast a similar trend earlier this month in its own 2013 annual outlook, predicting that more product and clarity on pricing encourages investors to move up the risk curve.
The continued release of stock by banks should see more product and clarity on pricing, allowing some investors to go beyond prime and leading to a recovery in investment activity, predicted DTZ, with volumes rising to €113bn in 2013 and further growth in 2014 to €118bn.
Hans Vrensen, global head of research at DTZ, wrote: “Lower quality properties are expected to be the next logical step for them to realise excess returns. Furthermore, rents for Class C offices are forecast to be stronger than for Class A in the next five years.”
Management teams will be the differentiating factor in 2013, argued the JPMorgan team, given the scarcity of rrental growth and Central Banks’ stimuli will be priced-in to a large extent.
“Managers should consider everything to create value, for example cutting costs, fine-tuning strategy, developments, using the low cost of capital and M&A.”
Cost of capital
The polarisation of European listed property companies’ ability to source low cost of capital will see the sector’s largest benefiting from eye-watering cheap cost of capital. The standout example is Unibail-Rodamco’s five-year corporate bond which was priced at a coupon of 1.625%.
“Using the low cost of capital, preferable in combination with opportunistic acquisitions, we have seen some companies making the plunge this year and with success, for example Great Portland, Capital & Counties, Deutsche Euroshop and Deutsche Wohnen.
“We need more of this ‘heavy lifting’ in 2013, as returns will be increasingly hard to make from the ‘core portfolio’.”
Bond issues tend to reduce borrowing cost, and therefore enhance earnings per share, although JPMorgan argues that retail bonds – which emerged as something of a mini craze in the UK during the second half of the year – are a bit too expensive.
“If bonds are oversubscribed, it is not great, it tells you that the yield is too high,” Meijer and the JPMorgan team argued.
2013: the year of the capital raise
JPMorgan makes the bold case for every European listed property company to raise fresh equity next year to seize the opportunities to buy secondary stock at distressed prices.
“You may think we lost the plot,” writes Meijer and team “but if prime is entering bubble territory indeed, whilst secondary is still ‘so so’, we need management action to sustain the sector performance.”
Great Portland Estate’s £140.6m equity raising in mid-November is an example of such a strategy to exploit the opportunities in the near-term, wrote JPMorgan. Great Portland said it had identified an increasing number of interesting ‘GPE-style’ acquisition opportunities across central London.
“Given that debt remains scarce for non-institutional buyers, the company expects to be able to exploit this market opportunity through identifying assets for it to reposition and having the financial resources to act quickly,” Great Portland said at the time of the equity placing.
JPMorgan called it “a smart move: [Great Portland] has capital to buy opportunistically at better returns than its current portfolio”.
“Some of the majors should consider equity issuance as well and exploit their expertise in more secondary markets, although the UK looks better value than the Continent.
“And those who are thinking about a joint-venture, should consider keeping the asset and raising equity instead. We sometimes wonder whether management teams fully realize the real value of their quality portfolio or access to quality developments in London. Don’t give it away too easily.”
Europe needs more ‘action heroes’
“What it comes down to,” continues JPMorgan “is the [European] sector needs more action heroes to sustain performance. Central banks want property companies to take action to de-gear the world; it is already ironic that quality companies are the main beneficiary of the low rates, whilst lower quality players struggle with financing and see their values falling.
“Central bankers want the quality players to act and save the world! In this way, our most recent survey results look promising: nearly 90% of listed property management teams expect capital raisings in the sector over the coming months, and 65% expect more M&A.”
M&A will be a focus next year, as earlier forecast by Morgan Stanley. At the end of November, Morgan Stanley forecast that 2013 could see a wave of M&A activity next year, particularly in the UK and France, with the latter market triggered by Spanish banks transferring equity or debt holdings to SAREB, the Spanish bad bank.
“In recent weeks we have already witnessed a UK small-cap putting up the ‘for sale’ sign, Local Shopping REIT, a merger between a mid-cap, London & Stamford), and a small-cap, Metric. We expect there to be more of this in 2013,” Morgan Stanley wrote.
JPMorgan’s take was consistent: “M&A can be a perfect way to reduce costs, improve management, lower the cost of capital and increase bargaining power against tenants in retail.
“Small-caps entered the M&A arena, both in UK and France, and one stock has even put itself up for sale. We believe that this trend will also carry on into 2013.”
London continues calling
The ‘London is booming theme’ will carry on next year, predicts JPMorgan, “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’. Also Shaftesbury recently said that London is more vibrant than ever.
“And we would 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 to the upside, and the upcoming residential boom in 2013.”
“2013 will be another exciting year,” concludes the JPMorgan team. Who can argue with that?
Merry Christmas from all at CoStar News – until 2 January…