Real estate opportunities

Interest rates across Europe look to be heading lower, which should spur economic growth. This is good news for the region’s real estate market, as lower rates are likely to lead to upward revisions in valuations through reduced cap rates.Cap rates reflect the return investors are willing to accept from property investments. They are usually calculated as a property's annual net operating income divided by its market value. But we believe that the resurgence of real estate will not be universal. Instead, we foresee a K-shaped recovery: the right assets in the right locations will strengthen, but assets facing obsolescence risk will never be cheap enough to be good value investments. In the latter category, for example, we can put many shopping centres, suburban offices and buildings that score poorly on sustainability criteria.

Through active management and prudent asset selection, we can construct a portfolio on the right side of the K.

Knowing which categories have attractive long-term performance profiles is only half the story; the other is identifying and buying the underlying assets in those categories. As any homeowner knows, nominally identical houses several streets apart can have very different price tags.

The number of opportunities we uncover allows us to make patience a virtue. Over the past several years in Germany, for example, we reviewed more than 300 potential transactions where we saw ways to add value amid favourable supply/demand mismatches. None offered sufficiently attractive entry prices, however, so we declined them all. Since the market has corrected, we are now able to revisit many of them where the fundamental investment case remains intact – but now at prices that are 25-30 per cent cheaper. This gives us great excitement for the future of the strategy. 

Investors have two broad options here: buy ready-made future-proof assets or create them. This is where we believe value-add managers have an advantage. Redundant buildings can be transformed into objects of desire.

Particularly as we see many motivated sellers. Some are simply capitulating; some recognise the long-term outlook facing their assets and lack the experience or financial capacity to modernise them.

In either case, value-add investors with the vision, experience and resources to reposition their assets can reap the rewards, especially in areas where demand is strong.

For example, we have acquired an obsolete and vacant telephone exchange in an exclusive area of central Madrid to develop into ultra-luxury residential apartments. Elsewhere, we have upgraded 125-year-old office buildings in Manchester to boast modern amenities and impeccable environmental credentials.

Of course, such work to improve assets cannot be completed overnight, although value-add initiatives can have shorter holding periods relative to other private assets. In our experience, the average turnaround time for an asset is 2.5 years. Because we are not buy-and-hold in our value-add strategy, we look to sell relatively quickly to longer-term ‘core’ owners who prioritise income streams over capital gains.

But strong rental performance is still important, even in value-add strategies. In 2023 – a year of lacklustre economic growth for Europe – we were able to strike new leases across our portfolio with rental increases ranging from 14 to 45 per cent. This shows that in some areas demand clearly exceeds supply, and that demand can be met by finding innovative ways to repurpose assets.