European market leads the world
Property companies in Europe are going through one of the most spectacular periods in their history. In the past year, European property markets have been the best performing markets worldwide. At the same time, the market is growing substantially. The GPR General Quoted Index, measured in euros, reports a total year-on-year return of 18.7% (August 1999).
After a period in which returns have moved at far less attractive levels, European property companies once again offer an interesting investment alternative. Obviously, the most interesting question to investors is whether this market is going to last, or if another downturn lies around the corner. Many of the elements needed to create a strong market, such as activity and size, are rapidly improving. Some other essential elements, like information and liquidity, still need a lot of improvement. If the market succeeds in filling these gaps, the future looks bright.
One sign of health is an active market, in which mergers and acquisitions take place. It is hard to keep track of all the deals being done in Europe at the moment, because there are so many. Undoubtedly spurred by the euro, companies are actively seeking partners to increase size and market strength to match the demands of investors changing their focus and investments from domestic to international. Especially in smaller markets, property companies are trying to create sufficient size to put their companies on the European map.
In Spain, Prima Inmobiliaria and Zabalburu are negotiating a possible merger, and the same is said to be happening for Urbis and Vallehermoso. In Germany, WCM and RSE are merging to achieve enough size to be included in the DAX Index. But the French property companies win the prize for being most active in 1999, with countless takeovers and mergers taking place. In the past year, Compagnie Fonciere, UIF, UIS and Sefimeg (all quoted property companies) were acquired – in most cases by the bigger quoted property companies. Gecina has been the most active property company in France. Barely having finished the acquisition of Sefimeg, the company has made an offer for Batibail. This proves that the managements of property companies throughout Europe are realising that they face competition not just from peers within their own country, but that they also need to compete with property companies in other European countries.
Most of these mergers and acquisitions are done to increase size. In 1998 the average market capitalisation of European property companies was e592m. This figure has climbed to e690m this year (see Figure 1). Because an increasing number of investors are investing by tracking an index that largely dictates the weight of a property company in a portfolio, size means demand. However, while increasing market capitalisation might help the trade volume, it does not need to influence returns in a positive way. Taking the GPR General Quoted Market Weighted Index for Europe and plotting it against the equally weighted index, we find that the smaller companies have outperformed the large ones historically. As information is relatively scarce in the property market, increasing size might even affect performance adversely as property companies will prefer to acquire real estate even though it is outside the focus of the company. A new stream of cross-border co-operation between property companies mitigates this problem. By teaming up, property companies benefit from each other’s experience, while substantial growth can be realised. In the past year, mainly German companies engaged in cross-border merger transactions. IVG bought the Swedish company of Asticus, and RSE increased its stake both in the Swiss property company Maag Holdings and in Prima Inmobiliaria of Spain. It is likely that this kind of activity will increase gradually.
Lack of transparency means that size is not the only thing that will make property companies an attractive investment. Supply of information is another key factor. Every day, Global Property Research is confronted with the problems of creating comparable information throughout the European markets to supply investors with information they can work with. An example of the shortage of sufficient information is that there are still a significant number of property companies that cannot provide any information in English. This makes it impossible for many investors to assess what these companies do. In addition, reporting is very slow in some countries. Especially in southern Europe, annual reports will be published more than nine months after the closing of the book year. In this era of information this slowness is extraordinary, especially in the financial markets. An interesting fact is that only 32% of European property companies own a web site. Also, analyst coverage is still very limited. Property companies in some countries are hardly followed by any analysts at all, whilst markets like the Netherlands and the UK have relatively decent analytical coverage. Without the information analysts provide, the threshold for buying into companies is kept high.
Analysts are facing the same problems as investors in trying to figure out which companies contain value. There is a continuing debate on how property companies should be valued. It is imperative that a method that can be used throughout the European property share market is developed, to further boost growth and knowledge.
In a mature market, one would expect property companies to generate returns in line with the long-term performance of real estate. Right now, some markets show an entirely different performance (see Figure 2) as a result of an increasing amount of information flowing to the market. A clear example of this is the German market. In Germany the property market has largely been dominated by highly illiquid bank funds. In the past two years, a new breed of highly active publicly quoted property company has emerged. Via restructuring and repositioning, these have become real alternatives to investors, and returns on these companies’ shares are reported in three, rather than one or two digits. Property companies in this phase seem to be the ones where most value can be found.
Institutional investors face the problem of having more money to invest in the market than liquidity allows them to invest. Large investors are solving this problem by buying into a stake from the company itself, or from another large shareholder that wants to move out of real estate. Two of the largest Dutch pension funds, ABP and PGGM, have both engaged in this kind of activity lately. ABP bought a stake in Klepierre of France from a bank that is selling off its position in property shares, and also bought into Bauverein Hamburg of Germany by taking over shares of Wuensche, a company that held 98% of the company’s shares. PGGM recently bought a 9.9% stake in Schroder European Property Fund, which is listed in the Netherlands. Both investors essentially had to buy into companies in this way, as the open market does not offer the opportunity to do so. Liquidity therefore remains a cause for concern.
In the GPR Handbook of European Property Companies, we compared the liquidity of 200 European property companies. We found that the British property companies are the most actively traded in Europe. As with analyst coverage, the markets of France, Switzerland, Austria and Portugal are the least liquid. These markets have in common that commercial property is, to a large extent, bank-owned. Now most banks are deciding to get rid of enormous property portfolios, the liquidity situation in this market might improve.
The increasing number of cross-border deals and the growth in the smaller property share markets is far from over. In the next couple of years, enough excitement is to be expected. New companies will be introduced, and the existing ones will be more active. Returns cannot be expected to continue in percentages like that of the past year, as property shares simply are not internet stocks. Instead, investors should be expecting moderate and stable returns. If the information flow also improves, the property share market will mature into a strong part of the financial markets.
Hans Op’t Veld is a partner in Global Property Research, based in Amsterdam