Cherry-Picking Deals in Europe

Equity-rich sovereign wealth funds (SWFs) are one of the few investors in a position to take advantage of real estate opportunities presented by the global financial downturn, and have been cherry-picking the best deals in Europe. The Korean National Pension Service, for example, has recently dominated the headlines for its high-profile purchases of the HSBC tower at Canary Wharf in London and the Sony Centre in Berlin.

“SWFs are calling the bottom of the market. They don’t think we’ll see further value falls. I expect to see them maintain focus on the biggest European markets for direct acquisitions,” says Michael Haddock, director of Europe, the Middle East, and Africa capital markets research at property consultant CB Richard Ellis (CBRE) in London, and the coauthor of the firm’s Global View Point: Sovereign Wealth Funds report.

Despite their access to capital and the pursuit to transact, SWFs have not maintained their appetite for investment throughout the cycle. Following significant losses in 2007 and 2008 due to investments made early on in the financial crisis— for instance, Government of Singapore Investment Corporation (GIC) took a $12 billion stake in Union Bank of Switzerland and Abu Dhabi Investment Authority (ADIA) bought into Citigroup for $7.5 billion—SWFs may have acted too soon and were subsequently cautious about reentering the market.

Dubai’s own debt crisis also curbed the spending power of some SWFs, particularly in the first half of last year. The crisis was sparked by state-owned development company Dubai World, which defaulted on its debt. With less money flowing into SWFs and instead being diverted into domestic infrastructure projects, for example, there was less capital available for deployment outside the United Arab Emirates. However, oil prices have since recovered, helping to reverse this situation.

Geographically, the majority of sovereign wealth funds prefer to invest in North American real estate, with 66 percent investing in that region. This is followed by 59 percent in Asia and 55 percent in Europe. Preqin says the Middle East and North Africa regions attract investment from 41 percent of SWFs.

As with most aspects surrounding SWFs, there is little transparency in terms of the returns they are seeking. Haddock explains: “A theoretical understanding of what SWFs are trying to achieve is simply better returns than their foreign exchange reserves. In practice, what that tends to mean is that they have relatively low hurdle rates. It is a capital preservation strategy rather than a return strategy.”

With thin corporate structures, SWFs typically favor prime assets with low input from a management perspective. Trophy assets provide an ideal target, given that they tend to be large, new buildings that accommodate one or two tenants with a strong covenant.

Last year, the Oman Investment Fund paid Hammerson £333.75 million ($504.2 million) for a stake in 1-10 Bishops Square in London, while the Libyan Arab Foreign Investment Company acquired Portman House on London’s Oxford Street from Land Securities for £155 million ($234 million). Outside of the capital, Australia’s Future Fund purchased the Bullring shopping center in Birmingham, also from Land Securities, for £210 million ($317 million). In Spain, GIC bought a stake in Unibail- Rodamco’s La Maquinista and Habaneras shopping centers for €215 million ($272 million).

While trophy buildings in major markets often represent a significant part of large SWFs’ real estate exposure, it is not only iconic assets for which they hunt. Indirect investments in listed property companies and real estate investment trusts (REITs), as well as indirect property funds, are designed to fill the gaps in their portfolios as SWFs do not want to employ the large numbers of people required to maintain big, directly held portfolios. Smaller SWFs tend to invest more indirectly because they do not have the scale or management resources to possess a truly global diversified portfolio.

Another common means of investing is via joint venture (JV) partnerships, in order to exploit segments of the market that SWFs believe have growth potential. They capitalize on the specialist skills of their JV partners by targeting established players with experience in their field. An example of this is GIC’s JV partnership with Russian developer PIK Group to develop a large urban township in Moscow. GIC paid around $233 million for a 25 percent stake in the project.

Other SWFs have targeted real estate debt strategies as a way of leveraging the uniqueness of their investment objectives and their long investment horizon. Since the global economic downturn began this has increasingly been the case, with the number investing in debt rising from 25 percent in 2009 to 31 percent this year, according to Preqin. The proportion interested in funds targeting distressed situations has climbed to 21 percent from 19 percent last year.

“This suggests that the debt and distressed space [have] become more appealing to SWFs, just as [they have] across the investor universe as a whole, as the current market suits these types of deals,” notes Preqin.

CBRE expects direct investments to be concentrated in core product in major markets, while JV partnerships and investments in unlisted funds will attract a growing proportion of SWFs’ real estate allocation.