Private real estate investors go global

Copyright: David Lawson – October 2000

Real estate is the most beguiling of investments. In countries like the UK and US, most people own homes and have watched bricks and mortar soar in value during a long period of post-war inflation. That equities and bonds soared even further is often forgotten. So is the pain of slumps and the fact that hyper-inflation is extinct.  Private investors continue to put their trust in property.

  A magic ingredient in the US are tax incentives which led millions to invest in real estate investment trusts. But even these giants pall beside the true individual investors and owners who hold more than 90% of  warehouses, offices and apartments, according to advisor  Prudential Real Estate Investors.  On a smaller scale,  competition among UK lenders has encouraged  thousands into buying homes to let.

Source: Prudential Real Estate Investors

   Private investment has moved into a new, global arena, however, in the hunt for better returns during an era of low interest rates on cash deposits. Many people rely on managed funds such as Greenwich Group, Blackstone and Apollo, which are pouring capital into Europe and Asia. German and Dutch investment funds are also active in the opposite direction.

 This is investment by proxy – much like buying real estate equities –  where individuals hand over decisions to the experts. ‘Private investors hate risk. This is the prime difference to institutional buyers,’ says Mark Morris, director of private client investment at international property consultant Jones Lang LaSalle.

  Even arms-length investing  involves some strategic choice, however.  ‘Approaches to achieve higher returns can vary considerably between fund managers,’ according to Joel Stoesser and Robert Hess, of  Prudential Real Estate Investors. 

Source: Prudential Real Estate Investors

  Strategic choices are more limited when private investors make their own way into direct property and leads to broadly different strategies to the professionals. ‘They are  mainly driven by a requirement for long-term capital growth,’ says Jeffrey Selwyn,  financial advisor with international real estate consultant Allsop Selwyn. ‘Institutions are looking for angles, development prospects and re-financing to add value quickly.’

   Private buyers  tend to borrow because of tax benefits, whereas institutions and banks can dip into their own equity.  Institutions  think big, buying perhaps a city-centre office block costing upwards of  £5-10m ($3.3-6.6m). They can live with sub-8% initial yields because plans will have been made to physically upgrade, review rents or reschedule leases, then capitalise on the capital uplift  by selling.  Private investors will usually aim lower – perhaps around the £1m mark  – borrowing between 60-80% of the cost. Yields must cover interest and transaction costs.

  So going it alone requires two levels of expertise: weighing direct real estate against other investments plus a local knowledge of markets.  ‘They are relying on maintaining income flow, whether that is in Los Angeles, London or Lisbon,’ says Selwyn. ‘That requires intimate feel for markets.’

    They don’t always get it right. Irish and Israeli investors bought heavily into the UK in 1998/99 because of they could borrow at sub-6% on gross yields often around 10%. That fell away earlier this year as the cost of money rose. Yet the best time to buy is actually when money costs more than yields but interest rates are likely to fall. A short-term hit is more than offset by lower initial prices and declining outlay.

 Asian investors burned their fingers on UK housing and US offices over the last decade through ignorance of local market trends. This sort of information can be bought  from brokers, but they work for sellers rather than offering strategic advice.

  Even where investors judge the cycle correctly, they can come to grief on individual buildings.  Structural conditions and the nuances of  leases both affect potential returns but seemingly risk-free covenants can collapse overnight after a single profit warning, says Selwyn.  ‘Location is the critical factor,’ he says. Good locations attract alternative tenants. Understanding local authority views on  potential change of use is also important in reducing risk.  

   Timing is another strategic factor. Institutions sell when they see little potential for short-term growth because a rent review may be years away. A building could also be ‘over-rented’ because open market values have fallen, so growth may be even further into the future. But private investors will often be happy with the prospects of a low-risk, long-term cashflow with a potential capital uplift at the end.

  This complexity has led to huge growth in consultancy as private investors choose a middle road between indirect funds and independent buying. In just three years, Morris has built an £850m portfolio among 25 private clients in the UK and JLL is about to extend into mainland Europe and the UK.