CAPITAL ADVISORS

FOUR QUADRANTS EMEA | April 2017

Keeping Calm And Carrying On

Public Equity

Public Debt

Private Debt

Private Equity

Capital Advisors Capital Advisors

Four Quadrants | April 2017

THE FOUR QUADRANTS HIGHLIGHTS



Public Equity

Public Debt • REIT bond issuance continues

• UK REITs continue to trade within a range of 10-20% below pre-Brexit vote pricing

• CMBS primary market has started to show more activity but limited to niche products

• Stocks with the right story have outperformed with strategy leading for the majors and income for the more retail investor orientated stocks

• UK interest rate environment continue to be favourable in the face of rising inflation expectations

• Investor demand for REITs with leading portfolios remains strong

Private Debt

Private Equity

• European financing market for prime assets remains very liquid

• 2016 shows slowdown in fundraising

• UK market is supported by alternative lenders

• Demand for core diversified exposure is unabated

• UK small ticket and development debt is harder to source

• Pricing of core UK fund secondary units has strengthened after post-Brexit dip





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Four Quadrants | April 2017

Capital Advisors

VALUE CHOICES IN THE FOUR QUADRANTS The title of this issue is purposely exaggerated to make a point about the current mood in the four quadrants of the real estate capital markets. It is reassuring that the sector did not crash after the Brexit vote or the US presidential election result but this was what experts predicted. Also the initial reaction to the announcement of the UK General Election has been muted, but it is very early days. The main reason for insiders’steady mood is that the real estate industry stands on good fundamentals and has a healthy balance sheet. The maturing cycle across most of the European markets, in combination with limited new supply, is generating rental growth and in some cases further yield compression. This continues to support transaction volumes; nevertheless, the majority of investors seem to agree that they should buy (or, alternatively, not sell) core assets in European gateway cities. Anecdotal evidence from CBRE’s sales teams show that core office stock is difficult to source or comes at eye-watering yields across London, Paris, and the main German cities, these being the bellwether for the rest of the primary locations across the continent.

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A similar dynamic plays out in other sectors. The same ‘move to core’ theme is apparent across all segments of the debt and equity markets. While private equity fundraising has started to slow down after a few years of unabated record placement volumes, demand for stable income continues to manifest itself both in the primary and the secondary markets. Similar signalling comes through the public markets. Debt financing is available and very competitively priced for prime assets on the private markets and for REITs with good balance sheets on the public markets. Investors in assets with less stable income streams and developers are also supported by the lenders although by a different lender segment and priced accordingly. In summary, we are keeping calm and carrying on albeit with a somewhat singular focus on property’s stable income streams.

© CBRE Limited 2017

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Capital Advisors

Four Quadrants | April 2017

DIRECT PROPERTY Investment volumes remain high Across Europe, total investment for 2016 was slightly down on the previous year (FY16: €255bn, FY15: €278bn), however the story of Q4 2016 was one of transaction volumes rebounding strongly. An all-time quarterly high of €87.5bn was transacted, driven by record high volumes in Czech Republic, Denmark, Germany, the Netherlands and Spain. Institutional investors remain attracted by stability in Western Europe and the Nordics, while those looking for a growth story are drawn to Spain and Central Eastern Europe (CEE). For Q1 2017, we do not see a significant change to the trend that emerged in the second half

of last year. Investors continue to seek exposure to safe haven assets resulting in further yield compression in a number of Continental European markets, mostly in Germany, Southern Europe, and capital cities in the Nordics and Paris’s La Défense.

What drives performance? Market fundamentals in Europe are increasingly favourable and economic growth is supported more broadly across the region. As the cycle matures, investors are looking for strong income-producing assets with upside potential in rental values. Although opportunities for rental growth are by no means evenly distributed across Europe, we see a limited development pipeline and solid tenant demand driving vacancy down (and rents up) across

MACRO SNAPSHOT

Continental European capital cities and strong regional cities.

• Both the EU and euro area economies are set to grow at about the same rate in 2017 as in 2016 (about 1.7% for the Eurozone and slightly higher for the wider area) despite the drag on real incomes from higher commodity prices • Upward revisions to UK growth expectations have been particularly marked despite Brexit-related uncertainty and the drag from higher inflation. Growth is now expected to be around 2% which is higher than that achieved in 2016

Structurally, the fundamentals of the logistics market continue to command attention, as do alternative sectors where demographics and supply constraints are supportive of future income growth. While the patchy recovery of the retail market has muted investment sentiment, opportunistic investors see value in the disconnect between the relatively strong occupier market and subdued investment market activity.

• The improvement in the economic climate has been achieved despite the heightened political uncertainty • The ECB extended its bond buying programme, which was due to expire at the end of March, to the end of the year which has helped to stabilise rates in the euro area • Yields on US Treasuries have trended sideways since the beginning of the year and gilt yields have actually fallen back

Figure 1: Most Attractive Cities for Investment in EMEA

The case for London

(Percentage of respondents from CBRE’s EMEA Investor Intentions Survey 2017)

The lead up to the referendum had a significant effect on take-up in London’s office market as occupiers held off making decisions. By Q4 2016 this changed and take-up strengthened significantly. As a result, take-up for the year was down only marginally on the 10-year average. We expect take-up to stay below trend as the UK economy slows, and supply will continue to rise, although at a moderate rate.

17.0%

15.8

LONDON

%

BERLIN

8.4%

MADRID

7.3%

5.4%

AMSTERDAM

PARIS

Source: CBRE EMEA Investor Intentions Survey, 2017

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© CBRE Limited 2017

Against this backdrop, office rents are forecast to fall in some submarkets in 2017 and all submarkets in 2018. By 2020, improving economic conditions will support a gradual recovery in take-up and therefore rents across most submarkets of the city. In the immediate aftermath of the referendum vote, investors stepped back from the London market. Central London office investment was down 19% for the year and office yields rose by 25 basis points in Q3 2016, although London’s retail market was more resilient.

By the end of the year, investors, particularly from overseas, had regained their appetite for London property. This momentum was sustained into 2017 with CBRE’s Investor Intentions Survey showing that London remains the number one real estate investment destination in Europe with city office yields reversed in Q1 2017 falling 0.25%. In fact, according to CBRE’s latest data, Q1 2017 was the most active first quarter of the year ever for London. London office investment totalled £4.9bn for the quarter, the highest quarterly total since Q4 2014.

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Four Quadrants | April 2017

Capital Advisors

PUBLIC EQUITY Trading

REITs

Since the beginning of 2016, we have seen the UK segment of the European public real estate stock markets c.10% down with a trading range of 10-20% down since the referendum. London focused names have fared worse by c.10% and more desirable strategies such as Segro’s high quality logistics with a European angle have fared best among the major names. In contrast to the UK REITs, the EPRA ex-UK Index has outperformed by c.15% in local currency terms with the weakness of sterling adding to that on a common currency basis. This is all much as expected and has been well covered.

There has been discussion of whether real estate equities are a leading indicator. This debate, in a UK context, largely revolves around expectations for the trajectory of interest rates, rental growth, and the impact of structural shifts on REIT portfolios – retail v logistics, London post Brexit etc. In this context, and largely referencing capital flows, one might consider the performance of the UK listed property trusts whose strong dividends appeal to the private investor, the same constituency who served redemption requests on the open ended funds last summer. These trusts have outperformed with, for example, Picton up 18%

over 2016/17, outperforming Segro and trading at a premium to last reported EPPRA NAV. This seems to demonstrate continuing investor demand for sustainable income, one of property’s principal attributes as an asset class.

Continued backing REITs We have also seen two significant equity placings from Segro, £340 million in September to fund the development pipeline and £556 million in March 2017 to acquire the Airport Property Partnership. It appears that there is demand from the equity market, both institutional and retail, for property stocks telling the right story.

Figure 2: REIT Prices 2016 - 2017 YTD EPRA exUK

EPRA UK

Segro

Great Portland

Picton

Unibail

130

Index 1 January 2016 = 100

120

UK Referendum Vote

110 100 90 80 70

1/4/17

1/3/17

1/2/17

1/1/17

1/12/16

1/11/16

1/10/16

1/9/16

1/8/16

1/7/16

1/6/16

1/5/16

1/4/16

1/3/16

1/2/16

1/1/16

60

Source: Bloomberg, 2017

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© CBRE Limited 2017

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Four Quadrants | April 2017

Capital Advisors

PRIVATE EQUITY 2016 shows slowdown in fundraising The prominence of real estate within institutional portfolios has grown over recent years increasing from 6.7% of AUM in 2011 to 8.5% in 2015, with average target allocations increasing from 9.1% to 9.8% over the same time frame. At a global level it is estimated that managers have c.$239bn of capital to deploy, but fund raising in 2016 slipped 15% from 2015 levels to $104bn.

Everybody wants ‘core’ Preqin reports that in Europe approximately €3.7bn of fund closings were announced in Q4 2016 for value-add and opportunistic strategies but this is at least matched by subscriptions to open-ended pan-European core funds which remain highly sought after. The problem for all managers and perhaps for investors who have subscribed is that prime assets in traditional capital hubs like London, Paris and the German top five cities

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© CBRE Limited 2017

are priced ever higher. Increasingly, investors and managers are venturing towards less liquid primary cities in markets such as Denmark, Belgium, the Netherlands and Austria – widening their investment horizons from office and retail to other more alternative sectors – logistics, residential, student accommodation and healthcare.

Pricing In the secondary market, pricing for core strategies strengthened in Q4 2016 and trading volumes increased. The UK, in particular, saw pricing strengthen after a period of generic weakness that ensued in the period immediately after the Brexit vote. Q1 2017 has seen a continuation of the theme of Q4 2016. Demand remains robust both in the primary and secondary market.

“The problem for all managers and perhaps for investors who have subscribed is that prime assets in traditional capital hubs like London, Paris and the German top five cities are priced ever higher.”

2017 has started positively and demand for exposure to the sector remains strong, but the search for value is not getting easier.

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Four Quadrants | April 2017

Capital Advisors

PUBLIC DEBT REIT bond issuance continues

CMBS primary market issuance limited to niche products

Markets for real estate public debt remain dominated by corporate bond issuance from the UK and European REITs. There has clearly been some outward movement in spreads, particularly as the benefits of issuing convertibles have dissipated with the fall of REIT share prices post Brexit vote. Nevertheless, demand for real estate backed corporate bonds is still strong and REITs are continuing to optimise their balance sheets through the issuance of new debt and, in the case of Land Securities, through the redemption of expensive historical debt. We expect further issuances going forward as the major players seek to take further advantage of the low interest rate environment in order to bring down their overall financing cost.

in bond format to aid future liquidity and broaden the potential investor base.

The CMBS market continues to be almost completely dry of any significant new issuances. We are however sensing an increased interest in the sector as a way of accessing lending in circumstances where some of the traditional banks have retreated, particularly some of the ‘alternative’ real estate sectors or for higher yielding mezzanine products. For this reason we would not be surprised to see some further issuance in 2017.

UK interest rate environment continues to be favourable Government bond yields have been rising across the Eurozone as investors fear growing political risk. In the UK rates market, gilt investors do not seem to be too concerned with higher inflation just yet, with ten year yields falling back from recent highs and the Bank of England seemingly reluctant to prioritise inflation control over economic recovery. In our view, this continues to present an opportunity for UK borrowers to issue long duration bonds and lock in their borrowing costs at the current low rates whilst both economic growth and inflationary pressures build.

Investment banks remain very active currently but their preferred distribution route continues to be the syndication market. We do however see a preference to structure loans

Figure 4: UK 10-Year Gilt Yields UK 10 year gilt yields

German 10 Year Govt Bond yields

2.0

1.5

Yield %

1.0

0.5

0.0

30/3/2017

16/3/2017

2/3/2017

16/2/2017

2/2/2017

19/1/2017

5/1/2017

22/12/2016

8/12/2016

24/11/2016

10/11/2016

27/10/2016

13/10/2016

29/9/2016

15/9/2016

1/9/2016

18/8/2016

4/8/2016

21/7/2016

7/7/2016

23/6/2016

9/6/2016

26/5/2016

5/12/2016

28/4/2016

14/4/2016

31/3/2016

-0.5

Source: Bloomberg, 2017

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© CBRE Limited 2017

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Four Quadrants | April 2017

Capital Advisors

PRIVATE DEBT European financing market is very liquid We have entered 2017 with a very liquid debt market, be it for senior, junior or mezzanine debt. Banks, debt funds and institutional lenders are increasingly becoming more competitive in their bid to lend to good sponsors against prime assets at ‘normal’ LTV rates. On the whole in Europe, financing is still readily available across most investment asset classes and terms have not changed significantly in the last few months. In addition, we have witnessed UK-based lenders who historically would not have ventured outside their ‘home market’ revisiting their strategy and looking to lend across Europe.

Alternative lenders The large UK clearing banks traditionally form the main channel for debt financing in the country. In the past few months we have seen them managing their books carefully and being quite selective about deals. The lending terms they are willing to offer have tightened with LTVs slightly coming down and some evidence of more restrictive covenants. This shift has not reduced the availability of funding as debt funds and other alternative lenders have recently raised sufficient capital and have seized the opportunity to ramp up volumes and take advantage of the UK market, particularly post Brexit vote.

Development debt harder to source In contrast to the investment market, financing for development in the UK remains difficult to access both in the residential and the commercial segments. This has been the case throughout the entire UK recovery phase as lenders seem to have grown structurally averse to the risk profile of development debt. Another segment that suffers from limited lender appetite is investment debt tickets smaller than £15m. As the economics of underwriting such transactions is not very favourable, a limited number of alternative lenders have been willing to fill the gap left by the UK clearers in this segment.

“Financing is still readily available across most investment asset classes and terms have not changed significantly in the last few months. We have witnessed UK-based lenders who historically would not have ventured outside their ‘home market’ revisiting their strategy and looking to lend across Europe.”

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CONTACTS For more information regarding this report please contact: Anthony Martin

Paul Lewis

Dominic Smith

Executive Director

Senior Director

Senior Director

Investment Advisory

Loan Advisory

Research

t: +44 20 7182 2466

t: +44 20 7182 2871

t: +44 20 7182 2369

e: [email protected]

e: [email protected]

e: [email protected]

Graham Barnes

Steve Williamson

Executive Director

Executive Director

Corporate Finance

Debt and Structured Finance

t: +44 20 7182 2516

t: +44 20 7182 2080

e: [email protected]

e: [email protected]

Paul Robinson

Michael Edwards

Executive Director

Executive Director

Alternative Investment

London Investment Properties

t: +44 20 7182 2740

t: +44 20 7182 3739

e: [email protected]

e: [email protected]

This report was prepared by CBRE Capital Advisors and the CBRE Global Research Team. CBRE CAPITAL ADVISORS Capital Advisors provides the full range of corporate, structured finance and capital raising services, together with investment advice for funds, portfolios, individual properties, indirect ownership services and complex situations. We bring together a unique mix of expertise in order to meet client needs. Our team of over 100 in EMEA includes accountants, bankers, financial analysts, fund managers and property professionals. GLOBAL RESEARCH AND CONSULTING CBRE EMEA Research Team forms part of CBRE Global Research and Consulting, a network of pre-eminent researchers and consultants who collaborate to provide real estate market research, econometric forecasting and consulting solutions to real estate investors and occupiers around the globe. DISCLAIMER 2017 CBRE Limited confirms that information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt their accuracy, we have not verified them and make no guarantee, warranty or representation about them. It is your responsibility to confirm independently their accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of the CBRE Global Chief Economist.

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