Playing the waiting game

The knights of the roundtable:
Martin Erbe
is the head of international ?real estate finance for ?Northern and Central Europe?of HelabaLandesbank Hessen-Thüringen. The Frankfurt-based bank has assets worth EUR 170.1 bln and employs around 6,000 people. Helaba subsidiaries include GWH, Helaba Invest Kapitalanlagegesellschaft, Frankfurter Bankgesellschaft and the OFB Group, which is active in real estate project development.

Stefan Aumann
a founding partner of Peakside?Capital and responsible for the company's asset management. In August the UK-registered real estate investment management firm finalised the acquisition of Allied Irish Banks' subsidiary AIB PPM, renaming it Peakside Polonia ?Management (PPM), for its Peakside Real Estate Fund I, focused on active asset management opportunities across Europe.

Otis Spencer
is co-head of KSP Real Estate Investment Management, an institutional real estate investment management platform with offices in Warsaw, Poland and Luxembourg. Over the next two years, it intends to raise EUR 200-300 mln of equity to invest in commercial properties in capital and secondary cities across Poland and the Czech Republic.

Michael Atwell
is head of CEE capital markets at CBRE. The Los Angeles headquartered commercial real estate services firm is the world's largest (in terms of 2011 revenue) and has app. 34,000 employees in more than 300 offices worldwide.

Tomasz Puch
is head of office and industrial investment at Jones Lang LaSalle. The real estate services provider was formed through the 1999 merger of US firm LaSalle Partners and UK company Jones Lang Wootton, which has origins dating back to 1783. This is the largest international merger in the real estate sector to date.

Michał Sternicki
is the general manager for Poland of Aareal Bank. Based in Wiesbaden, the international real estate specialist bank is listed on Deutsche Börse's MDAX index and provides property ?financing solutions in more than 25 countries.

Nathan North, 'Eurobuild CEE': Could I ask you first of all about the general mood of the investment market?
Michael Atwell, CBRE: There's a general air of cautiousness combined with uncertainty about what's going to happen next year. We all saw 2011 as a bumper year - a very, very strong year. This year the activity has certainly slowed quite a bit. So now people are asking, what is going to be the outlook for next year?

Nathan North: And they are asking this in a pessimistic way?
Michael Atwell: No, not in a pessimistic way - it's just the uncertainty. Whether it's the finance/debt-side of it; whether it's the availability of the product; whether it's a case of some of the investors slightly withdrawing from the market and becoming less active. It's just the uncertainty that's creating the nervousness.

Martin Erbe, Helaba: As an example of this, we were recently talking to a fund that was thinking about buying out one of its co-investors in a transaction. Eventually they decided: no, we are going to keep our equity in our own pockets because we do not know what is going to happen next. The thinking is that if we invest our money today, we will probably need money in the future - either to deleverage on loans or to invest in upcoming opportunities. When you start up a fund you have to invest the money, but existing funds are keeping it in their pockets at the moment for those unforeseen and uncertain moments in the future.

Otis Spencer, KSP Real Estate Investment Management: The key concept is ?dry powder', to be able to deal with issues that may come out of deleveraging. But what we are seeing in starting a new fund is the challenge right now in getting equity. But there is institutional investor interest in the core central European markets - Poland and the Czech Republic. People are still saying that they want to invest in the region, but what they don't want is volatility. What we are getting in terms of feedback is on the amount of leverage - why don't you use 40 pct? Others are saying, why use any leverage at all? Take away that element of volatility and buy all-equity, buy good quality projects that have good quality covenants with tenants that have a future.

Michael Atwell: Good quality means prime. That's quality, security, stability. The opportunistic eyes are still on the market, but there is more appeal for the prime product.
Otis Spencer: But really, where can investors put their money right now? Look at what they are earning on the money market from so-called safe investments - they're just not yielding. So if you can get good quality covenants and secure income in a region that still has growth prospects, that's a pretty compelling opportunity.
Stefan Aumann, Peakside Capital: Actually, we've seen since the last financial crisis that funds are saying they want to keep their powder dry. So money is a side-line issue here. The question is will the capital ultimately come into play, or will people just wait for deals to happen? We have seen this before, but it just didn't happen because there was no liquidity. The owners of real estate, if they were not distressed, were just not prepared to sell at these price levels.

Otis Spencer: We know that some funds with non-core assets that are maturing should be selling their assets, but the market is so limited for these secondary assets if they have any kind of blemish, whether it's a unexpired lease term of less than three years, or it's viewed as being in a very illiquid secondary/tertiary city. And so cap rates go up and people are now talking about them going into double-digit figures. Without debt issues, investors might decide to take an extension, hold it, collect the cash, and see where they are in 24 months. That's on the sell-side. On the?buy-side we are seeing cap rates going up for good quality assets that a year ago were sub-7. Now they're in excess of 7. Tomasz, would you concur with that?
Tomasz Puch, Jones Lang LaSalle: That's pretty much what we are seeing in the market today, but contrary to what you are saying Otis about investors liking to sit and wait, they may still have excess cash issues. We have seen a case of one fund in Germany blamed for not spending the money. Even though you are saying that potentially investors are on hold, I think there will still be some pressure from one or two investors looking to spend money, because it is better to spend it than just give it back.

Michael Atwell: I would agree with that. We are getting enquiries from investors that are actively looking for assets. It's not as if there has been a sudden stop.

Tomasz Puch: For sure we will get investors for the regular type of product where you have three-to-four years' duration but depending on the asset category and required pricing.

Martin Erbe: What has become the key for most of the funds is not fund-raising or investing, but asset management. Because if you have a property where you have, say, leases for the next 12 to 18 months, or if you are just a new fund starting fresh or an open-end fund, you need clear and good asset management. This is the key today and will remain the key into the future.

Otis Spencer: I don't want to make this into a sales pitch for my new organisation, but that's why we joined up with KSP because they brought the operator skill-sets closer to our business plan execution rather than us being an asset allocator like some of our peers. We have in-house capabilities, such as project management - and saw that as the differentiator.

Michael Atwell: Wasn't this also?the case several years back, when the market weakened? - it was all about asset management and how to work the assets? Asset management has always been coming back and now is absolutely the key thing.

Otis Spencer: Yes, there are two important elements beside capital raising and capital deployment - and that's asset management and executing your business plan, as well as the debt-management plan. So you really need to understand what's going on, and be in constant negotiation or discussion with lenders to avoid issues. And when it comes to having a good debt-management plan, you can't outsource that.

Stefan Aumann: Poland strikes me as a market where the usage of debt and leverage has not been as excessive as in other markets. In Germany we can see that many of the deals done in 2005-07 now have LTV issues. Yes, there has been leverage here recently of about 80 pct, but it strikes me that leverage levels in Poland have been used a bit more prudently compared to Western Europe.

Tomasz Puch: I think to some extent this is a result of who the buyers were. We didn't have investors who were highly leveraged. If you look at the demand-side, this was predominantly German and Austrian money.

Stefan Aumann: Coming back to the point about uncertainty, for me one key issue is what happens on the occupier market. It becomes a real problem when we see a downturn on the occupier market, because this will impact your income and your debt facilities.

Nathan North: Is the uncertainty now impacting investment in the office ?development sector in any way? Can we see any changes in the Warsaw market?
Martin Erbe: We still have around 700,000 sqm of office space planned or already under construction on the Warsaw market out of a total stock of around 3.7 mln sqm - so we have almost 20 pct of potential new stock. Taking the pre-lets out, we could say that a massive amount of new space will come onto the market in the next few years.
Michael Atwell: It's true that the CBD is still holding out quite well. We are seeing investors targeting the CBD and looking at Mokotów and saying that they're not quite sure. There's a lot of supply there coming up, whether it's from potential sites or those under construction. There's still a lot to come in Mokotów, and that's where we are starting to see the rents slightly soften. Investor demand is quite bad, especially in those areas where traffic congestion and parking is more of an issue.
Otis Spencer: We actually made a conscious decision not to pursue assets in Mokotów, and to concentrate more on the CBD, taking into account the better transport links and the prospect of sustainable rents.
Martin Erbe: I think this was a good decision.
Michael Atwell: I've been away for four years, and coming back I was surprised to see that ?Warsaw's western corridor hadn't developed as much as I thought it would. The metro is going to make a big difference, but that's still about two years away. I still think that the western corridor market has yet to fully come on-stream, and there's a lot to come.

Nathan North: Coming back to the point about investment volumes, it does seem that they have fallen considerably in the CEE region over the last three ?quarters. Is this only to do with there ?being more uncertainty on the market?
Tomasz Puch: If you look at the CEE region as a whole, you are right; but if you look specifically at Poland there is not much of a difference. The difference between H1 2012 and ?H1 2011 is marginal.
Martin Erbe: Last year the first half was around EUR 1 bln, this year it's about EUR 950 mln.
Tomasz Puch: In the Czech Republic, which had EUR 280 mln in H1 2011, now it's about EUR 250 mln.
Otis Spencer: Just to go back to the point that volumes are down because it is just taking longer to close transactions, we have to ask, who's making it more difficult, is it the buyers or the banks?
Michał Sternicki, Aareal Bank: The delays are not only because of the banks, but also due to the equity side. It's taking longer because investors are more cautious. Banks have not really changed their policies in the last few months, but those who are actively lending have been cautious and will remain cautious. While the cautiousness on the one hand relates to the risk assessment of a given transaction, on the other hand it is being influenced by the uncertain market environment for banks while the regulatory framework still remains to be clearly defined and is still evolving. Banks are trying to comply with the Basel III rules and are looking for a stabilised economic environment, which at the moment remains elsuive. In a nutshell: today's lending environment is influenced by many factors, including the expectations of the equity side, the changes to the regulatory framework under which banks are currently operating, etc. In relation to the closing of deals one important observation is that a number of transactions are not closing because the pricing expectations on the vendors' side are not being met by the buyers. It is also worth noting that a number of financing requests are based on a medium to long term holding strategy by the investors as opposed to a quick turnaround and exit. This gives the investors stable returns and protects the equity over a longer investment period.
Martin Erbe: I think that's definitely a good point. I mean, the banks haven't changed their internal processes and strategies that much. Of course there is Basel III ahead of us, but we all know this and know we have to cope with it. At the?moment it is clearly the investors who need more time especially for their decision making processes. In the past investment committees were pretty easy to convince, but now questions are coming back - do we have to do this? Is this the right moment? etc. And then the second part is clearly that investors willing to sell are not jumping certain hurdles regarding the expected sales price, and have to go back to investment committees, either asking for new approval to sell at a much lower level, or they have to approach the banks and - here comes the trigger - investing fresh equity, getting re-financing for a few more years, and - by working on the asset - achieving a higher sales price in future.
Otis Spencer: We keep talking about Poland, are we saying the other markets are dead? The Czech Republic is much slower, but Hungary does seem to be rather dead.

Alex Hayes, ?Eurobuild CEE': This connects with the question about whether the?dominance position of Poland in the ?region for investment is likely to ?continue, and if so, for how long?
Tomasz Puch: Definitely until?the year-end, but then next year it's difficult to say, because there's a big question mark over which transactions will be brought to the market in the Czech Republic next year. Some investors will definitely be getting out. We all know a number of closed-ended funds will be under pressure to sell and in the next 24 months have to sell. So Poland is probably going to continue to lead for the next two years, I would say.
Martin Erbe: I think that the Czech Republic will have a number of big deals that will help it to keep up over the next six months.
Michael Atwell: The Czech ?market has always been impacted and dominated by big deals. You can get a couple of big ?ticket deals and it hugely sways the numbers. Even in Poland ?if you get a deal like the one ?for Manufaktura, then bang! ?It's great for retail investment volumes and then there could still be more to come. In the Czech Republic this is ?particularly true.
Otis Spencer: What's the view in Germany? You don't just have a capital city, but regional ones like Frankfurt. Do you see the volumes falling dramatically in Germany as well?
Martin Erbe: I think the volumes are falling but not dramatically, last year the volume was about EUR 23 bln, this year it is a little bit lower.

Alex Hayes: Can we get back to the CEE region? What happens if Poland and the Czech Republic fall into recession? Would that be the end of investment here?
Michał Sternicki: For Poland and the CEE we expect an increased input from domestic investors, so some of the shortfall/demand will be partially covered by that. Some foreign opportunistic investors might refrain from the CEE markets because they can't get the right product or the right returns, but there will be a number of domestic investors who will be looking at this. And they will be of different sizes, from small investors to large ones, both private and institutional. Will they get the expected returns? A partial answer to that question is that it depends on the availability of EUR loan funding and the number of financial institutions willing to provide it, in particular in relation to construction loans. A possible alternative scenario could be a shift towards Polish currency funds. Should this happen investors would need to think about which currency they are going to seek leverage in. Will it be in euro or in local currency? And in the case, for example, of ?Polish currency, how are they going to arrive at a Polish yield? Whatever investment strategies?are chosen by the fund managers, it is an unquestionable fact that the demand is likely to increase from domestic investors.
Martin Erbe: I think we should not see Poland and the Czech Republic as completely isolated, as investors are also looking at the rest of Europe and wondering where they can invest their money. Countries today compete with each other for investment.
Stefan Aumann: I would echo that. I mean the question you raised is what will happen if there is a recession in these two markets, but I think the question should be where the development will be compared to other markets. Even though you could argue that Poland is on its way to becoming a core market, will it be better or worse than the rest of core-Europe? It's hard to say. Obviously in a recession transaction volumes will go down, but the main question is, by how much this is going to be?
Otis Spencer: Yes, but the feedback we've had from investors, and these are pan-European?investors, is that Poland is a much safer bet than - let's say - Spain. So Poland is now part of that conversation and they want a certain allocation for ?Poland and for liquid assets here. I think it's no longer a conversation just about ?Warsaw, but there's increasing?interest in secondary cities, of more than 500,000 people, where there's this whole story about the BPOs. A lot of leases?are being signed with good quality covenants with a much better yield than in Germany, for example.
Stefan Aumann: I would agree with you. I think that we have almost got to the stage where people are saying that they need to be present in Poland investment-wise. Given the economic performance in the last crisis investors seem to be acknowledging the relative safety and positive performance of the Polish real estate market.
Nathan North: I think that's a suitably optimistic-sounding note to be ending on, at least when it comes to our part of the world. Thank you all for your expert analysis.