Stepping out in partnership
It’s always a big step to invest in real estate outside your home market, but if you are one of the biggest life insurers in the world, nothing less than a giant leap will do. Through its in-house fund management arm, Morley, the Norwich Union Life Companies will invest e1bn in continental European real estate over the next four to five years.
The life fund’s asset allocators have opted to include continental European real estate as a separate asset class with a separate benchmark, rather than as a sub-sector of the overall real estate allocation – the life fund already owns £12.9bn (e18.4bn) of UK property and Morley has a 80-strong UK property team. Most of the allocation will be invested indirectly, either in joint ventures with local
partners or co-mingled funds.
Morley head of property Ian Womack says: “We have been looking at the continent for a good four to five years now, but previously the risk/return equation did not work for us. That began to change over the past 2 years and we recommended it to the life company clients in April. The board very quickly supported the agenda, as it was something they had always wanted to implement, subject to planning and opportunity. The life fund is basically a core-plus investor and we are now seeing more opportunities for that level of risk/return across Europe.”
The life fund is looking for overall returns of around 12% from its investments. It has already invested £250m and Womack believes it could have €500m committed within six months “if everything we are doing right now comes off”.
Increasing transparency in continental European markets over the past few years has been a major factor in the move, despite lower return expectations – especially in central European markets, where US opportunity funds have been active for several years. Also important was the life fund’s increasing demand for diversification.
Morley’s head of property research and strategy Nick Mansley says better access to data has been key. “We have been able to factor in greater transparency and, while the market has got hotter, it’s both easier to deliver returns and be able to have a much better feel for what returns are actually out there. More reliable data enables a stronger case for the diversification benefit for continental European property as an asset class.
“Looking at it in isolation, the continent looks attractive in terms of the returns available and the risks involved. Put it in to the portfolio and it really helps. The life fund - like many investors - has become more concerned about diversification; it has come to the fore over the past five years – and continental European real estate is a good diversifier.”
Ben Stirling, appointed to manage the continental European investment drive says the fund is looking for a broad geographic spread. “France is a key focus for us due to its size and liquidity,” he says. “We are also seeking to identify opportunities in southern and central Europe where returns are relatively attractive. We will be underweight in Germany although there could be very interesting opportunities in the future as things start to unravel and that market opens up.”
The fund has chosen the indirect route in order to avoid having to set up a regional infrastructure for Europe, but also because of Morley’s success in managing funds with real estate partners. UK examples include the £1.6bn (e2.3bn) Mall shopping centre fund, set up in partnership with developer Capital & Regional. Morley manages the vehicle, in which the life fund is a major investor, while C&R manages the assets.
Stirling says: “The investments will be mainly be indirect with some sort of theme to the vehicle or relationship. All the vehicles I am working on will be core-plus, with limited gearing - we’re happy with around 50% - and asset management opportunities. We won’t be developing from the ground up but we won’t be buying prime city centre assets either.”
The first completed joint venture has been with logistics developer Partridge and takes the form of a e200m fund to develop and own distribution parks in central Europe. The parks will be developed on a pre-let and speculative basis in Poland, Hungary, Slovakia and the Czech Republic with an average park size of 80,000m2. The venture, run from Parkridge’s Warsaw office has already bought four sites and has identified a further five.
Womack says alignment of interest with partners is the key to success. “Everything we do in our business is about that. We manage the funds, they manage the assets and share in the pleasure and pain. Having partners with sector and local knowledge is the major de-risking factor for us. People talk about transparency; well markets are different and cultures are different so that’s a risk you have to manage. Often, in small less-developed markets, finding the right stock is the major problem. Our partners can supply people on the ground, deal with local legal structures and have the contacts in the local market.”
Sourcing partners is not anticipated to be a problem. Firstly, the partnering system has become more widespread on the continent and is a well-accepted way to do business. “More investors are investing cross-border who have a good cultural fit with us,” says Womack, and discreet feelers were put out while the move into Europe was being considered. “There’s both a top down approach - which countries and sectors we have identified through research and bottom-up - where we can find local partners. People come to us with proposals. We have made it known what we want and have become more well known over the past few years. We’ve been having ‘what if’ discussions for a couple of years now,” says Womack.
In addition, a number of existing investments outside the UK will become part of the new allocation. These include stakes in the Prologis European distribution fund and the Curzon Global Partners European Property Investors Fund as well as the Liffey Valley shopping centre in the Republic of Ireland. The life fund’s 25% interest in the Global Switch limited partnership - which owns a number of data centre assets in Europe -will also be transferred.
A range of structures will be used for vehicles, with the aim of ensuring as much tax-transparency as possible. Morley will use the Luxembourg fonds commun de placement (FCP) and is working on a vehicle with a UK limited partnership structure with a Luxembourg sub-structure. “Luxembourg will tend to feature somewhere as Morley has a big presence there,” says Stirling. “If you are trying to invest in a tax-transparent way on a pan-
European basis, through Luxembourg is the best way to do it at the moment.”
Morley is working on the creation of a pan-European core-plus fund which will invest in all sectors. While the life fund will be the main investor, it will also be open to other funds around Europe. “In the longer term, we would like to see some secondary trading in the vehicles and some liquidity,” says Womack.
Most structures will have a seven to 10-year lifespan, although Womack stresses that decision to invest in continental Europe is a long term strategy. “We here for the duration; tactically we will treat individual investments as we do in the UK and will swap in and out where appropriate, but we will not abandon what is, after all, a whole new asset class.”
Despite the reliance on partners, Morley is making a significant investment in staffing. “Property is labour intensive; if you’re going to do it on a big scale you need people to do it properly. Even if, like we do, you are sticking to the higher end you need the bodies to do it,” says Womack.
So far, Stirling has been joined by assistant fund manager Julian Taylor, who previously worked for Heitman International where he was a vice president in the European acquisition team working in the Central European, French, German, Italian and Spanish markets. New staff are still being recruited and Womack says there will be six staff working on continental Europe by the end of the first quarter of 2005.
Looking further into the future, Womack says he would not rule out direct investment, although this will never be a major part of the strategy. “Might we buy, say, a big Spanish shopping centre. Possibly. But we’d want someone in their with us, even if only with a minority stake, a bit of ‘hurt money’. The last thing we want to do is manage a Spanish shopping centre from London. And we don’t want to put in a property management infrastructure on a pan-European basis.”
The development of a European REIT market - which looks ever nearer as the UK, Germany and Finland progress with their individual campaigns - could provide access and liquidity for cross-border investors, but Womack does not believe investing in European REIT securities would be a substitute for private real estate investment. He says that, as property company securities are dealt with by Morley’s equities team, it is most likely that they will also deal with REIT investments.
“REIT performance is closer to direct property performance than property company performance – but its closer to the wider equity market than to the direct asset performance. In which case it’s not the diversifier the life fund needs. But, as I said, we hope to gain some liquidity through vehicles we set up.”
The strategic move outside the UK has been a major move for Morley and its in-house clients – will it be the springboard to investment further afield? “We continue to look at other regions and will carry on researching them in the same way as we have done with continental Europe,” says Mansley. “But we’ve no plans to take that leap yet.”