Re-thinking real estate

Attendees at this year’s EPRA conference were forced to reckon with the social and political challenges facing the industry on a global scale

Adorning the grand halls of the Landmark Hotel in Marylebone, London, this year’s annual European Public Real Estate Association (EPRA) conference, the event for European listed real estate investments trusts (REITs), focused on a theme of ‘RE Think’, assessing the challenges facing the industry over the next three to five years.

EPRA set the ball rolling with a press conference that saw the launch of not only its new branding, but also a number of key announcements intended to take the European listed real estate industry to new heights.

The European association set out its stalls with a call for Solvency II reform, which it said could lead to a dramatic stream of investment into European real estate, as changes in capital requirement rules for insurers would allow listed real estate to be treated like direct property investment.

Under current Solvency II rules, the capital risk rating weighting required for listed real estate is 39 percent, compared to 25 percent for direct property investments.

Dominique Moerenhout, CEO of EPRA, said: “If we are successful in convincing the EU [in Solvency II reform] we estimate we will double the market capital of Europe, moving from €250 billion today to €500 billion, in Europe alone.”

“EPRA is strongly petitioning the European Commission to cut this burden from around the industry’s neck under the Capital Markets Union Action Plan and the Solvency II review.”
According to EPRA, the European insurance investment industry is valued at €10 trillion, but its investment into real estate is extremely limited.

Moerenhout added: “Pension funds and insurance companies are looking for a higher-yield asset to match their long-term liabilities. It is an opportunity for the industry, and the listed real estate sector is perfectly positioned to address those elements.”

Solvency II, made fully applicable in the EU in 2016, is designed to safeguard insurance policy holders in the event of major losses.

The situation is different in the US, where pension funds are the dominant source of investment into real estate.

Mark Abramson, director of the European REIT Heitman, said: “My 20-something years of experience in the capital markets screams at me that if the risk charge goes down on REITs, then it could unlock hundreds of billions of euros in capital from the insurance industry. Even a fraction of that would be extremely positive for listed real estate in Europe.”

EPRA’s call for reform came with impeccable timing as the listed real estate industry was given a boost, with FTSE Russell announcing it has carved out real estate as a new Industry Classification Benchmark (ICB), following consultation with the market.

The new ICB real estate benchmark comprises 4 percent, or $2 trillion in investable market cap, as a percentage of market cap weight of the FTSE Global All Cap Index. The structure will be effective after market close on 31 December 2018.

Moerenhout said: “REITs continue to grow globally as they provide investors stable long-term dividend income streams.”

“FTSE Russell’s elevation of real estate as its eleventh ICB industry is timely, as the listed real estate industry is growing strongly and is increasingly viewed as an investment asset class in its own right.”

The real estate ICB was carved out of financials, whose remaining weight, at 20 percent, is still the largest industry in the index, based on preliminary analysis of constituents as of 30 June.

Dr Christian Bahr, head of market data and analytics at SIX Swiss Exchange and a member of the FTSE Russell industry classification advisory committee, said: “FTSE Russell has undertaken a significant and comprehensive enhancement of its industry classification framework following a market-wide consultation.”

“FTSE Russell is not only bringing the best-of-breed to investors with this alignment, but it is also reflecting the evolution of industries and laying a critical foundation for future classification expansion.”

As keynote speakers discussed the uncertainty surrounding global socio-political events and the ways in which technological advancements could have a seismic effect on the industry, as well as the planet, EPRA had an idea or two on how it planned to contribute, presenting a series of new reporting initiatives focusing on environmental, social and corporate governance (ESG).

The new guidelines, which will take effect in 2018, will aim to provide common industry metrics for non-financial disclosure covering diversity, employee development, health and safety, and community engagement.

Since 2012, EPRA’s Sustainability Best Practice Recommendations (SBPR) guidelines have focused on companies reporting transparently on their environmental performance measures.

“The industry has now reached the point that we’re able to turn our efforts towards improving transparency on corporate ESG metrics, where I’m sure companies will also rise to an equally tough challenge”, said Moerenhout.

Sustainable investing has been of growing importance to investors over the past few years and, according to LaSalle’s report, Environmental Factors & Real Estate Demand, investors focusing on ‘green assets’ could achieve returns of up to 65 basis points more than those not investing sustainably.

The new initiatives follow a record number of top awards for sustainability for Europe’s listed properties at the 2017 EPRA conference, reviewed by JLL’s Upstream Sustainability Team.

Of the 134 who reported—117 EPRA members and 17 non-EPRA members—36 companies won a gold award, a 44 percent increase compared to 2016. The total number of winners has doubled since the first survey in 2012.

Moerenhout added: “European listed real estate companies have consistently raised their game every year since 2012, when EPRA began rewarding compliance with the Best Practices Recommendations for sustainability reporting. The recent big jump in the performance of our Swedish and German members is particularly impressive.”

Of the 36 companies that won the gold award, nine were first-time entrants to the index, while four companies, Unibail-Rodamco, British Land, Kiepierre and Citycon, achieved the gold award for the sixth year running.

An EPRA spokesperson said: “It was also very encouraging to see so many EPRA BPR award winners amongst the 400 attendees at the conference, with the level of BPR compliance reaching 78 percent by market cap of the FTSE/EPRA National Association of REITs Developed Europe Index against 69 percent last year.”

In sector news, EPRA attendees heard that discounts on office assets have gone too far, leaving investors with selective buying opportunities as part of the Brexit effect.

Small cap companies and self-storage operators now offer the most opportunities for investors, said Peter Papadakos, managing director of Green Street Advisors.

Papadakos said: “European real estate is better placed that US real estate. We expect falls in the value of office assets in the UK, but it won’t be dramatic.”

He added: “US REITs trade at 10 percent discount to net asset value (NAV), the UK [REITs] are also trading at 10 percent NAV and continental REITs are just about trading at NAV. So perhaps you could say the UK and the US are cheaper than the continent.”

In London, Papadakos expects vacancy rates in London to peak at 9.7 percent in 2019, compared to at 5.8 percent as of H1 2017, due to the Brexit effect. However he believes the take-up in the technology space could act as a counterweight.

He said: “As an offsetting element, the creators of tech are taking a lot of office space.”

Green Street Advisors, a real estate research firm, has predicted that London will lose approximately 40,000 financial services jobs over the next five to seven years, due to the loss of automatic passporting rights to the EU single market.

Finally, an investor panel discussing trends in the real estate market suggested that retail assets are being capped in line with other real estate asset classes.

Retail cap rates fell to 7.7 percent in Q1 2017, down from 7.9 percent in Q1 2016, and have consistently stayed below the 10-year average of 8 percent, according to REIS data.

Speaking on the panel, Scott Crowe, chief investment strategist manager at CentreSquare Investment, said: “If you go back 20 years, retail cap rates were quite high, it’s only recently that they have endured this lower cap rate.”

According to RCA data, retail deal volumes for July 2017 decreased by 54 percent compared to July 2016, and by 21 percent year-to-date.

“The US is over-retailed compared to Europe by about 50 percent, so it’s not as dramatic as the five-times number that gets a lot of attention,” Crowe said.

However, retail’s poor performance in the market and the emergence of ecommerce has led many asset managers to rethink the way they are positioning the asset, with many opting to create more of an experience for the customer.

Rounding up the conference Moerenhout, said: “This was my first EPRA Conference and I was delighted by the quality of speakers and the ideas they set out for our sector to consider. I was also very pleased to see well over 120 investors on day three attend our speed pitching sessions, and this is a format I am keen to continue and grow.”

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