What is alternative real estate? One tends to think of assets that are outside of the main categories of office, retail and industrial, but is it right to think of residential, mixed-use, hospitality and healthcare as being away from the beaten track or some fringe activity? PropertyEU spoke to market experts and highlighted nine case studies for our special report.
To Daniel While, head of research and strategy at Primonial, alternative real estate is real estate that delivers an ‘illiquidity premium’ because it is scarce, specialised property. ‘That is how I recognise alternative real estate compared to the mainstream,’ he says.
‘Offices and retail properties for example are the most liquid assets in real estate, and they often require a direct relationship between the owner and tenant. It is not intermediated by an operator. ‘Alternative assets are less liquid, which is not a problem so long as it shows in the yields. We have what I call an “illiquidity premium”. For example, healthcare real estate systematically delivers around 200 basis points of yield more than prime CBD offices.’
Scarcity and an operator
One of the reasons why alternative assets are somewhat scarcer than mainstream property such as retail and offices is because there are often higher barriers to entry. For example, in the case of care homes, they require an agreement from the local authority. Further, not everyone can operate and manage such an asset.
This holds true for other types of specialist real estate as well, from hotels to data centres, student accommodation, and self-storage. In specialised real estate, one can think of the physical asset as being an essential ‘tool’ that the operator must use well in order to optimise revenue from its core business. Because the characteristics of assets can be so particular, in some circumstances investors can capture a triple net lease where the obligation is upon the tenant to pay the expenses of the property such as maintenance, taxes and insurance.
Investor interest
But why has there been an explosion of interest in alternatives? Partly, it is because of the dramatic downside of cyclical or structural weaknesses seen in offices and retail. Real estate as an entire asset class has traditionally been owned by institutions as an alternative or supplement to owning shares in public companies and bonds.
Real estate with its long leases serves as a risk diversifier. But this is less true nowadays of mainstream asset classes such as offices and retail as leases have become shorter, and tenants or ‘customers’ demand greater flexibility and more services from their landlords.
Things are changing – and not really in the favour of the landlord. Offices are at the mercy of global economies and financial markets, and physical retail is at the mercy of consumer spending habits. Enter alternative real estate, whose underlying drivers such as ageing demographics or the need for more data can provide greater risk mitigation and diversification.
That said, the current Covid-19 crisis has indeed underscored how some alternative asset classes are far from immune to major shocks and can certainly perform differently, depending even on the country where they are located. James Snaith, director of operational capital markets for Savills in London, who principally advises on student accommodation and multi-family sectors across Continental Europe, says student housing is one of the more mature alternative sub-asset classes. ‘During Covid-19, occupancy has varied across different locations,’ he says.
‘Northern Europe coped well and has demonstrated resilience. For example, KKR attracted strong interest from all sorts of institutional investors when it sold some student housing. Pricing was way above expectation. But southern Europe has seen mobility issues leading to fewer institutional investors. That said, we have still seen transactions, such as Commerz Real buying into Henderson Park and Hines’ PBSA project, 22@Barcelona, which we brokered.’
Because operators do not tend to move in and out of operationally critical premises very often, it is possible to sign long leases or triple net leases typically indexed on inflation, which pleases investors. There is quite a low probability of the operator of a hospital, for example, wishing to move in a few years. The one asset type where traditional long leases are not the standard, however, is for hospitality assets where variable rents are common, and for which owners have suffered massive declines in occupancy and income during the recent Covid turmoil (though there are not yet many distressed trades of hotels).
Big and listed dominate
Whereas with office properties, there are countless reputable and dependable tenants, the issue in alternatives is that industries can be oligopolies. This means the landscape is dominated by a handful of operators with pan-European businesses. These operators are frequently big and listed. While some have provided the holy grail of sale-leaseback transactions when they look to reinvest in their core business by releasing equity from their real estate, these large players can present a challenge to an investor when it comes to negotiating lease terms. Smaller investors in alternatives tend not to have the necessary bargaining power.
The second issue is that owners must understand the business of the operator and the latest underlying trends. Only with sufficient knowledge can investors come to know the ‘right’ level of rent compared to operating costs, say experts. ‘We want to keep tenants on a very long lease, so we need to keep them at the correct level of rent and be able to renegotiate in five or six years,’ says Primonial’s While.
Knowledge is king
‘There is an ambiguity,’ he adds. ‘Investors sometimes question why they should pay management fees to a manager like us when there is a 12-year lease and nothing to do for all that time. But not really. If we want to sell the asset in 10 years and there is only two years of the lease left, typically no one is going to want to buy it. It is not going to be liquid at all if we do not have a long lease to offer, so we have to renegotiate with the operator in order to make the asset liquid, and we want to start with the right level of rent to be able to progress that.’
Knowing the business model means keeping up with the trends in the industry. In the healthcare sector, a woman might have stayed in hospital for up to a week after giving birth but now it is down to two days. This is known as ‘ambulatory’ care in this sector. As operators’ profit comes from the volume of health services, they need to organise and use technology to be a service provider. Investors need to understand all the dynamics to make the right decisions and benefit from the investment.
Clemens Schaefer, head of real estate APAC & EMEA at DWS, says his company expects to see sustained and growing investor demand for alternatives for several reasons. First, he agrees alternatives typically provide an illiquidity premium which is generally not available in traditional asset classes. For example, dividend yields in real estate and private infrastructure are still significant. Second, because income generated in many alternative asset classes is contractually linked to inflation, they can provide a high correlation to inflation, stable earnings growth and competitive total returns.
Third, DWS also sees investor demand broadening across several alternative strategies into non-listed real estate and infrastructure debt, private equity, and sustainable investments. ‘These types of investments also provide an illiquidity premium. Given the performance attributes and the breadth and depth of the alternatives market, we expect sustained investor demand,’ he says.
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SECTOR SPOTLIGHT
Who is making moves in the specialist real estate arena? From residential to healthcare, data centres and hotels, we profile some of the protagonists and standout deals.
SINGLE FAMILY RESIDENTIAL (SFR)
Big capital coming to Immo
Single Family Residential (SFR) has not yet become institutionalised as an asset class in Europe as it has been for years in the US. But companies in this space see a transition about to begin. In the US, Blackstone showed investment firms could be successful in building up large institutional-quality SFR platforms. Proof of concept came as the New York-based private equity company formed Invitation Homes in 2012 and sold its shareholding in 2019 after taking it public in 2017. The company has since returned to the sector via Tricon Residential. SFR will also pick up in Europe, says Samantha Kempe, co-founder and CIO of Immo Capital.
‘The reason this is exciting is because obviously residential property is the largest asset class in the world, and about 98% is single residential or single units. But by using traditional manual processes, it has been completely inefficient for any institution to be able to deploy large-scale capital into the sector. That is where technology for the first time is beginning to unlock this asset class in Europe, and that is what Immo is doing.
’Immo was started almost four years ago and has offices in the UK, Germany and India. It is a tech-driven platform that covers the whole chain from sourcing the single family housing typically direct from consumers, to performing the underwriting and carrying out refurbishments using technology to plan and quality-control refurbs, and then lease the property.The company has mainly been operating in Germany, but plans to expand across Europe. As well as developing the platform, it has been busy building investor relationships to generate €1 bn-plus of pipeline capital and assets.
The potential is there for all to see. In March, Germany’s Allianz Real Estate said it had committed $300 mln to housebuilder Lennar’s newly formed subsidiary in the US to expand its footprint in the SFR rental sector. So, some investors clearly have hundreds of millions of euros to deploy with a firm such as Immo.
Says Kempe: ‘As long as there is a liquid rental market, this asset class works for institutions. It provides them with an incredibly stable income-producing core exposure. There is no development risk and the assets become income-producing within a few months of investment.’ Importantly for ESG aspects, Immo is taking existing stock and upgrading it in order to offer a better-quality product to consumers.
‘This is ultimately a consumer product. We have not just approached it as a real estate asset. Our tech platform provides 360-degree viewings, docu-sign leases, digital check-in, a rapid ticketing service for repairs and maintenance, and so on. We have people from Uber and Google, Amazon and other tech companies. It is about treating the tenant as a consumer.’
LIFE SCIENCES
Time to outshine in Europe
Readers may not be aware of the origins of third-party ownership of life sciences real estate. According to Bill Hunter, co-founder of new US company, Outshine Properties, it was started by two mortgage brokers in San Diego. They witnessed how property owners would lease up space to laboratory end-users who wound up being bought by big pharma or would grow and grow by themselves.
In the lab investment world, the brokers saw how tenants usually paid to finish the space they leased, and so the second, third or fourth generation space became more valuable with each tenant but with zero investment from the owner. In effect, the owner made an upfront investment, and the asset appreciated in value as it became more established.
Hunter’s Outshine Properties specialises in life sciences real estate. Together with managing partner Jonathan Scheinberg, Hunter launched in New York at the end of 2020. Take a note of the name, because he says the firm is likely to make its debut in Europe within 12 months, marking another entrant to what has become one of the hottest alternative and specialist real estate asset classes in the market. Hunter met Scheinberg while the pair worked together at Thor Equities, which launched Thor Sciences in 2019. Hunter was asked to lead the platform, which made several large acquisitions.
Outshine so far manages 1 million ft2 of life science assets in the US and is in talks to buy more assets to reach 3 million ft2. Hunter has spent 20 years in the life sciences sector including at BioMed Realty Trust which was founded by sector doyen, Alan Gold. He says: ‘Cap rates when I started making acquisitions in 2003 along the Pennsylvania Route 230 were 13-14% with high-credit tenants, but now they are 4.5%. It has been a wild ride. The sector has spent 15 years in obscurity and now this space is so hot.’
He adds: ‘I am a huge fan of western Europe. The only thing it lacks in my opinion is the government-sponsored component of funding that is the most important factor in the US. I would say the UK is about 15 years behind the US in understanding the third-party life sciences ownership model, but it is quickly evolving. One of the benefits of the Covid crisis is that governments will see merit in sponsoring research to stay ahead of the curve.
’He believes existing facilities will be rationalising in the UK as the sector evolves further. In the US, owner-occupied space is shifting towards a decentralised research campus model. Hunter’s experience lies in taking premises with single tenants to create multi-tenanted operational strategies for those campuses, which become clusters in and of themselves. ‘The companies that have done asset rationalisation strategies in the US are now looking at the UK,’ he says.
HEALTHCARE
Care-related assets in rude health
If you want a clue about demand for care home portfolios, look no further than Threestones Capital. In January, the boutique alternative investment manager attracted a total of 50 expressions of interest when it placed a package of assets on the market in Germany.According to the group, the level of bidding was ‘unparalleled’ and led to the largest healthcare property deal in years. Threestones Capital sold the 27 properties to eventual successful party Swiss Life Asset Managers for €425 mln, allowing its Gefcare fund to return the target performance of 13% net IRR to its investors.
Managing partner Giovanni Perin said the company was set up a decade ago and has been focused on healthcare real estate ever since. ‘It was just after the financial crisis and it was difficult to invest,’ Perin recalls. ‘Healthcare wasn’t sexy at the time. It was complex and nobody wanted to do it.’
Now institutional demand is rampant. Tapping that feverish appetite, the company is currently targeting €1 bn AUM for its fourth fund, Eurocare IV, with a view to attracting up to €500 mln of equity commitments. A first close is approaching after receiving strong interest from both existing and new institutional investors. Similar to previous funds, Eurocare IV will mostly be targeting existing properties in Germany, Italy and Spain, but will also on an ancillary basis invest in pre-let developments and forward deals. The fund will also look to expand into other attractive European markets.
‘We are looking to grow our portfolio in Spain where we currently only have six assets, and where we see significant investment opportunities,’ says Perin. ‘As the portfolio size grows, we may also open an affiliate office in the country to be closer to the assets.’
STUDENT ACCOMMODATION
Keeping it local
Investors are teaming up with specialists in local European markets to create student accommodation platforms. There are plenty of examples, some of which are yet to be made fully public. For example, Deutsche Finance International (DFI) and operating partner SF have created Blaekhus, which has quietly become one of the largest professionally managed and branded student accommodation platforms in Denmark, providing access to over 1,000 units.
The units are tailor-made for domestic and Nordic students as well as young professionals in sub-markets of Copenhagen and Aarhus close to large educational institutions, amenities, and transport. DFI and its partner have assembled the sites with local developers. In Denmark, student numbers increased by 15% to around 270,000 from 2011 to 2018, according to DFI. This growth has been driven by a 28% rise in international students. The system makes tuition affordable for students because the Danish government pays.
Student loans and stipends are also available to cover living costs. Estimated average rents for students rose 13% between 2015 and 2018 as demand continues to outstrip supply of accommodation. Across Europe, while Covid-19 had an effect on this class of specialist real estate, it was not impacted as much as feared.According to The Student Housing Annual Report 2020 by advisory company, Bonard, the purpose built-student accommodation (PBSA) sector saw occupancy levels across Europe running at a better-than-expected ‘reasonable’ level.
‘Student housing has proved itself a resilient, low-risk defensive asset class with a counter-cyclical nature,’ said Bonard CEO, Samuel Vetrak.
MIXED USE
A Squaire peg in a round hole
Sometimes, mixed-use assets are judged unusual enough to be described as requiring special treatment. One example that hit the headlines recently is The Squaire in Frankfurt. Germany’s largest office building was the subject of discussion when Bank of America Merrill Lynch launched a €473 mln securitisation of a €548 mln senior loan it made last year against the 145,000 m2 property, which is located above the airport’s train station.
Details of the refinancing deal showed the latest valuation was 11% lower than the price thought to have been paid by the new owners, which is a consortium of international investors led by AGC Equity Partners and including Hana Financial of South Korea. Current occupancy is 96% but The Squaire also includes two hotels, where according to rating agency, Moody’s, the rent fell from €21.6 mln to €4.6 mln last year due to trading problems caused by Covid-19. Real estate people responded on social media when PropertyEU shared its report.
Charles Pridgeon, former CIO of Allianz Real Estate and now a director at Euroche, posted: ‘It is a peculiar asset that has always been difficult to value because of a number of issues, not least the lease breaks and hotel component as well as other restrictions. Jordi Goetstouwers, formerly of Lone Star Funds and Eurazeo Patrimore and now president of Virgata Group, said he was a former board member of a previous owner.
‘I’d say that it’s a very unusual asset in too many ways to fit into a LinkedIn comment. It’s not an asset that allows you to draw conclusions from the market at large.’ Property services firm Savills says ‘mixed’ makes up 30% of the alternatives universe, followed by healthcare and student housing which command 23% each.
GROUND RENTS
The ground beneath their feet
Ground renting assets has become a specialist area, with a few companies keen to step into situations to help solve financing of assets. A new such situation arose in April when PropertyEU learned how JLL had switched tack on advice to the owner of Crowne Plaza London The City hotel near Blackfriars Bridge and the River Thames. Initially, the ownership sought to sell its interest for around £100 mln (€115 mln) to value-add funds, but the rumour is that pricing was a problem.
Given insufficient interest, JLL began marketing the freehold on behalf of the Galadari Brothers to long-income investors for upwards of £50 mln on the potential sale, subject to a ground rent. The asset has 204 rooms, two restaurants and three bars along with meeting rooms. It is operated by InterContinental Hotels Group (IHG).
In the UK, there are several long-income investors that have been involved in ground renting assets, including alternatives such as hotels and care homes. They include Alpha Real Capital, Long Harbour, M&G Real Estate, Aberdeen Standard Investment, PGIM, Aviva Investors, L&G, Nuveen, CBRE Global Investors, LaSalle Investment Management, Church Commissioners, BBC Pension Fund, and Consensus Business Group. However, it is not known if these companies have been approached. The sale or creation of commercial ground rents has been growing in popularity in recent years. Investors argue they present a compelling alternative to fixed income.
Typically, in the UK ground rents are long-dated, generally over 75 years, with rents paid by the corporate tenant to the freeholder for the use of the property asset. Recently, investors have been expanding their model from the UK to Continental Europe. For example, in March, Long Harbour completed the structuring and acquisition of commercial ground leases for assets in Dublin and Frankfurt on behalf of the Long Harbour European Secured Income Fund I (LHESIF I).
Richard Silva, fund manager for LHESIF I, says: ‘The interest we have seen so far in ground lease deals is very promising and underlines the strength of the ground lease structure and its potential in Europe, particularly for commercial assets. We are in active discussions on further deals and will be looking to broaden our portfolio in Germany and Ireland, as well as to make further acquisitions in the Netherlands and the Nordics.’
DATA CENTRES
Merlin conjures up special powers
The biggest constraint in the development of data centres is securing power, according to experts. As large data centres can use as much electricity as a small town, power is crucial but often overlooked. Spain’s Merlin Properties decided to bypass the problem and teamed up with sustainable energy group Edge Energy to set foot into the sector. The two companies plan to build a network of ultra-efficient, waterless data centres in major Spanish cities, using Merlin’s existing land bank.
‘This solution clearly gives them an advantage over the rest of the market,’ comments Stephen Beard, co-head of Knight Frank’s data centres team. For an industrial property landlord like Merlin, the move into data centres represents a minor shift in strategy, while allowing the firm to diversify into an emerging asset class. An asset class, one could add, that is experiencing unprecedented growth all over Europe. Like industrial buildings, data centres need large plots of land in well-connected locations near major fibre-optic trunk lines.
The main difference though, is that they can generate higher rents on a longer-term basis, says Beard. ‘While the shell construction of a data centre is similar to industrial assets, the rent is different. In the case of the latter, rent is higher for the ground floor than for the mezzanine and upper floors, because racking and stacking is only possible at base level. For data centres you do not need racking and stacking so ground floor rent can be applied to every floor.
’A longer lease duration – typically 25 years – also applies. This is because data centre operators are burdened with the most expensive part of setting up a data centre: the infrastructure. This, of course, makes a strong case for the tenant to remain in the building as long as possible.
HOTELS
Hit hard, but headed for better times
Speak to advisory groups, and they will say similar things about the hotel sector. Some of their workbook consists of tenant replacement advisory or working on refinancing options for owners. They also say that on the whole, distressed hotel deals have not materialised much, thanks to lender-borrower agreements and some pricing mismatches between potential vendors and buyers. In terms of sales, perhaps half of current mandates are formal sales processes such as Nobu Hotel Shoreditch in London, while the other 50% concern discreet conversations with a handful of parties.
That is certainly the case at JLL, according to head of EMEA Hotels & Hospitality, William Duffey, who also says hotel trades have dropped to €1.13 bn in Q1 2021 from €4.96 bn in Q1 2020. However, he expects much more activity in H2. Plenty of firms are gearing up for this, not least Stoneweg, a private equity real estate firm formed in 2015. It has just hired CBRE hotel expert Miguel Casas to the newly created position of managing director, Stoneweg Hospitality.
Joaquín Castellví, co-founder and head of acquisitions, Europe, says: ‘We retain a high conviction in hotels which we believe will see a strong recovery as economies across the globe emerge from the pandemic.’ Stoneweg is joined by the likes of Tristan Capital, which recently recruited Luc Boschmans as MD of hospitality investments across Europe. Although the hire appeared to be in response to potential distressed opportunities, he says the decision was actually made before Covid-19 and was a long-term play. He adds that tech innovations meant investment professionals needed to keep up, which they have been able to do during this quieter investment period.
VIRTUAL LAND
Living in a virtual world
The real estate market has been on a bull run prior to Covid-19, and not just in the real world. There are thousands of plots of virtual land for sale, with some of them changing hands for big bucks and people buying them every day. The virtual real estate boom is largely thanks to the invention of ‘non-fungible’ tokens, non-fungible meaning ‘unique’.
These guarantee immediate ownership of virtual property, and some people are starting to believe that the digitalisation of everything in life will someday lead to virtual real estate being larger as an asset class than the real thing, according to experts from cryptocurrency information source, Coin Bureau. For the moment, the current leader in the virtual land market is Decentraland, a virtual reality platform powered by Ethereum blockchain, which uses Mana as a cryptocurrency.
For readers not yet up to speed, Decentraland is a virtual community consisting of 90,000 parcels of land measuring 16x16 metres. Each parcel exists as a non-fungible land token on the blockchain and can be developed upon. Some parcels are used for roads, and some are plazas owned by a decentralised community. At the centre of a plaza is a ‘genesis bud’ where virtual players in the virtual world are spawned. Located around plazas are districts that are owned by individuals or organisations. ‘Squares’ that appear on a screen in light blue are for sale. The closer they are to roads, plazas or districts, the more valuable they are.
Decentraland Conference Center has spaces that can be leased for meetings, office space, retail stores and outdoor leisure. Virtual casinos use Mana for money. Virtual concerts are another form of entertainment using land that has been built upon. Meanwhile, luxury fashion brand Gucci is reported to have entered the non-fungible token (NFT) world, and it is brands such as these that have helped give rise to the e-commerce boom in the virtual sphere. Although Decentraland has been worked on behind the scenes since 2015, it really only launched in February 2020 when it opened its doors to the public. Institutional money is beginning to come in.
According to Coin Bureau, in just over a month, $10 mln has gone into buying a Mana token from institutional investors. User adoption of the cryptocurrency and its value are rising. But will it catch on? Only 1,000 users are on Decentraland daily, it is reported. But with Covid-19 dragging on around the world and the growing use of virtual reality games and lifestyle choices, some folk predict platforms such as Decentraland and others like it such as Axie will see higher adoption. This will lead to virtual land values rising further, giving confidence to institutional capital to one day enter the fray. Parcels do change hands among private investors, with some valued at tens of thousands, some at hundreds of thousands, and in some cases even millions.