Please give an explanation of the firm. Where is the focus of your investment and why? What is the particular investment strategy of the house?
JER Partners (JER) is a private equity firm focusing exclusively on real estate investments. JER has been active in Europe since 1994 and runs its European activities out of the London office with a staff of 25 headed by its European president, Malcolm Le May. JER has built its business by capitalising on market disconnect which disrupts capital flows and can cause mispricing. The investment strategy includes purchasing portfolios of real estate linked assets and loans, public to private transactions, corporate and government divestitures, restructurings and repositionings, and distressed situations. Since 1997, JER has raised three funds primarily focused on North America and two purely European funds. It plans to launch a third European fund in the near future. The European operation currently owns assets in the UK and France, and is exploring future opportunities in these markets in addition to Central and Eastern Europe and the Nordic countries.
Europa Capital Partners (Europa) is a boutique manager of closed-ended property funds.
The company is owned by five members of its management team, having effected a management buy-out of the 50% interest held by co-founder Sir John Beckwith.
The company now manages one fund, the Europa Fund, having successfully completed the first two, which were a UK mezzanine capital fund and a French property fund. The Europa Fund invests throughout western and central Europe. The place the house occupies is the property equivalent of a mid-cap investor. It seeks out off-market investments under the radar screen of the large investment bank dominated opportunity funds and larger, typically, than the majority of local players. The strategy includes development, redevelopment and refurbishment.
O’Connor Capital Partners is a US based real estate investment and management firm with European headquarters in London and operating offices in Milan and Luxembourg. O’Connor concentrates on direct investments in high quality assets in major markets in North America and Europe and invests in all property types. O’Connor’s European business focuses primarily on the core Western European markets of the UK, Italy, France, Spain and Germany and on retail, office, residential and industrial asset types. A strong network of European operating partners works with O’Connor’s team to heighten deal quality and flow in O’Connor’s European markets.
How does the opportunity fund sector break down in terms of ‘opportunities’/investment internationally? Is it still largely driven by regional and global funds? Is there any point in a specialist country fund?
JER: The market sector is primarily driven by investor demand. As investors become more sophisticated, they are moving away from global funds and creating diversity in their portfolios by investing in regional and sector specific funds. JER believes that the ability to identify opportunities across sectors and countries within a certain geographic region should not be restricted in order to ensure a truly opportunistic approach.
Europa: The origin of the opportunity fund sector is in the US, however opportunity funds have become international. The amount of funds with a truly global reach is quite limited and the size requirement to run a global fund management activity precludes this approach for many managers. Some sector specific fund managers of a certain size can also operate internationally with their expertise being transportable. However, investors would seem to favour fund managers with a regional expertise including local deal-sourcing and execution capability over the generalist global activity. The important evolution has been the emergence of local European owned and managed teams. There is still a case for country specific funds. From 1996, a number of country specific funds were created for investment into French Real Estate. The market must be large enough but there are clear advantages in terms of the range of exits available. Niche funds have found favour, particularly with the smaller endowment fund investor universe. Larger investors, such as the US State retirement systems have been prepared to invest $75-100 million in a regional or global offering.
O’Connor: The focus is moving away from a global focus towards a regional one. There are few specialist country funds because it tends to be too narrow of a focus.
What have been the most important trends/factors affecting opportunity fund investment in recent months?
JER : Over the last few years the global economic slowdown has caused a lack of tenant demand, which has been the main driver for the decline in real estate markets. However, the historically low interest rate and inflation environment, combined with a flight from equities and search for yield, has led to a disconnect between real estate fundamentals and pricing in many real estate markets. Despite falling rents and rising vacancies, investor demand for prime real estate, especially from the German open-ended funds, has kept capitalisation rates low. As a result of large sums of available capital there has been increased competition in the opportunity sector over the last two years. 2004 is expected to be a year of stabilisation driven by improving economies in the US and certain European countries.
Europa : In Europe, the continuing economic weakness of the core western European markets has created weakness in the occupancy markets. Tenants drive property investments and this weakness increases risk.
There is a dislocation between the occupancy markets and the investment markets. With short lease terms prevalent, there will be some asset management challenges arising within the markets most heavily invested over the last few years.
The German open-ended funds are now being joined by significant cross-border capital flows.
The emergence of tax transparent vehicles will enhance the retail and institutional appetite for real estate in due course.
The enlargement of Europe will provide a new investment focus, albeit adding only 5% to the EU GDP. The weak dollar is causing some investors concern.
O’Connor: As always, competition from lower cost capital.
What kind of returns are you aiming for with your latest fund/s and what do you think has impacted on possible returns – positive or negative?
JER : Our European funds aim to achieve an annual return, net of all fees, of 15%. Return expectations have clearly been driven down by increased competition in the opportunistic arena as well as from the core and core plus investors, including open-ended funds.
Europa : Opportunity funds should be seeking returns net to investors after tax, promote and fund costs at least 300 basis points higher than core plus funds. This means 16%-20% net, net, net, although some would argue that lower returns are acceptable. Continuing weakness in France and Germany and uncertainty in the occupation markets will impact upon this recent batch of fund returns, but the target of 20% net, net, net is still achievable. Europa Fund II will seek returns in excess of this.
O’Connor: O’Connor manages in both the opportunistic and value added space. The two Peabody funds, Peabody International and Peabody Global, are opportunistic funds with targeted 20% plus returns. O’Connor North American Property Partners is an opportunistic fund targeting 18% net to investors. O’Connor European Value Added Fund will be a value added fund which will target 15% net to investors.
What levels of leverage do you tend to apply to your funds?
JER : JER Europe Fund II will use appropriate leverage for each transaction, however, on aggregate, the fund aims to remain well within its maximum 80% leverage restriction.
Europa : We apply up to 75% LTV on a fund basis, although the current level of leverage is mid 60%. This can be due to the relative weighting of non-income producing investments, which allow higher or lower leverage.
O’Connor: 65% (value added) to 75% (opportunistic)
How do you approach the issue of risk and how is this communicated to investors?
JER : Our investment funds target high risk-adjusted returns. Risk is mitigated through intensive due diligence analysis and the preparation of detailed business plans, by diversifying investments across a large number of assets, various asset types and geographic markets, and by identifying assets with multiple exit strategies.
The internal risk management department is dedicated to continuous monitoring of changes in market conditions and provides investors with quarterly reports, including projected changes to performance, to achieve the highest standards of transparency.
Europa : We approach risk in terms of assessing and mitigating it. We recognise the aspects of an investment, assess whether the risk is commensurate with the return, model the expected outcome for the investment and stress the figures to create a sensitivity to the core elements such as rent and yield movement, interest rate movement, holding period, etc. Communication to investors on this subject is carried out through regular reporting and the investments we accept must fall within the investment guidelines we establish at the outset.
O’Connor: In multiple ways: property risks, interest rate risk, and currency risk. O’Connor gives full disclosure of all risks to its investors.
Have institutional investors been investors in opportunity funds to date? If not, why? If so, what are the attractions of investing in the opportunity sector?
JER : Institutional investors from the US still represent a significant percentage of JER’s overall capital. Although the opportunistic real estate fund is a relatively new product for most European investors, institutions are becoming ever more comfortable with the sector. The main attraction for investors is the increased risk-adjusted return.
Europa : Corporate pension funds, state and provincial pension funds, insurance companies, banks are all substantial investors. Endowment Funds and university funds are also investors, favouring the smaller funds. The investment arena has been dominated by North American investors. The continental Europeans, particularly the Dutch, have begun to adopt the multi-manager approach to real estate as a class, although the risk/return and leverage limits have limited appetite until recently. UK investors have been strangely slow on the uptake, due to the traditional separation of the asset class with its own in-house “surveyors” and a lack of familiarity within the ranks of the in-house investment team and their actuaries. The defined benefit funds in other places such as Australia are now looking globally at the opportunity funds, although the size of these funds are small.
North American investors are geared up to understand the offerings and clearly focus in on the attributes that differentiate between managers. The larger European funds are now doing the same. Typical institutional funds, particularly US funds who invest 10/15% of total assets in real estate, will divide real estate into core investment (which can be direct investment and can be in loans), core-plus and opportunity funds.
O’Connor: Yes, due to opportunity funds’ attractive absolute returns.