Real estate investors passing over U.S. to find good deals in Europe

With only pockets of competitively priced investment opportunities in the U.S., real estate investors are roaming Europe looking for bargains.

U.S. institutional investors are moving more capital across Europe than ever before.

For example, officials at the $187.4 billion California State Teachers' Retirement System are selling off domestic real estate in favor of properties in Europe. In May, the $34.3 billion Illinois Municipal Retirement Fund, Oak Brook, launched a search for a core open-end European real estate fund manager for a $100 million account.

The $14 billion New Mexico Public Employees Retirement Association invested up to $75 million in real estate debt fund DRC Capital European Real Estate Debt Fund III; while the $24 billion Texas Municipal Retirement System and $3.7 billion Houston Firefighters' Relief & Retirement Fund committed $100 million and $25 million, respectively, to Kildare European Partners II, an opportunistic real estate fund.

Europe also is a target of managers. The five largest real estate funds doing road shows — targeting a combined $17 billion — will have exposure in Europe, according to London-based alternative investment research firm Preqin. The five are Blackstone Real Estate Partners Europe V, focusing on Western Europe; Blackstone Real Estate Debt Strategies III, targeting Europe and North America; Oaktree Real Estate Opportunities Fund VII, a global fund; Colony Distressed Credit & Special Situations Fund IV, also investing in Western Europe; and Hermes Real Estate Senior Debt Fund, investing in the U.K.

Opportunistic managers were the first to invest in Europe to take advantage of distressed opportunities. Now, U.S. institutional investors are directing massive amounts of capital to Europe to take advantage of the region's anticipated recovery, said Sabina Kalyan, a managing director and head of European research in the London office of real estate manager CBRE Global Investors.

Real estate investors and managers think the U.S. market is overpriced and quantitative easing is coming to an end, which could lead to higher interest rates and cause the U.S. economy to slow. And that would be bad for real estate. Rents in hot markets such as New York and San Francisco are already starting to drop.

“The U.S. has had the best years of its cap rate compression behind it,” Ms. Kalyan said.

Europe is in the early stages of a classical economic recovery, so there is more opportunity for real estate investment growth, she added.

“U.S. investors are looking at where Europe is in the cycle and they see opportunity,” said Colm Lauder, a vice president at MSCI Inc. based in London. “Investors are seeing good value and a good diversification benefit for U.S. portfolios.”

Investors also are diversifying their portfolios in case the U.S. markets weaken after the presidential election, he said.

About 50% of real estate investors worldwide indicated plans to invest in Europe over the coming 12 months, a June 7 report by Preqin said.

Investors and real estate managers also are moving beyond trophy assets in gateway markets such as London and Paris and now scouting for deals in Ireland, Italy and France, said Joe Valente, a managing director and head of research and strategy, European real estate, in the London office of J.P. Morgan Asset Management.

U.S. investors and their managers are going abroad, betting that the lagging economic recovery in Europe will afford good buys. The continued quantitative easing measures in Europe is keeping long-term interest rates low and even negative in some countries, benefiting real estate.

“In the short term, QE has been a real positive on the (real estate) market,” Mr. Valente said.

But how it plays out in the longer term is a different question. “We're in the midst of the biggest financial experiment the world has ever seen, and no one knows exactly how that is going to unwind.”

“There is more new interest in Europe today,” said Nancy Lashine, managing partner and founder of New York-based placement agent Park Madison Partners. “There's a general sense of caution in the U.S. as the U.S. markets continue to appreciate and reach or exceed prior peak pricing. It's not cheap here, and so they (investors) are looking to see if properties are cheaper anywhere else.”

Ms. Lashine agreed there is a prevailing view that opportunities exist in Europe because the recovery across many parts of the Continent lags the U.S., and investors are pursuing that investment view.

Jonathan Grabel, chief investment officer of the New Mexico Public Employees Retirement Association, Santa Fe, noted the U.S. has outperformed the rest of the world in most asset classes for years. Over the past five years, domestic equities dramatically outperformed the rest of the world by an annualized 500 basis points, he said.

“That kind of performance is not sustainable,” he added. So officials are looking elsewhere. PERA's investment in European real estate debt is an example of the opportunities that exist outside the U.S. due to macro factors, he said.

At CalSTRS, executives are investing in European real estate in part because the recovery there is two or three years behind the U.S., leading to the potential for lower prices in the region. “From a pricing standpoint, some assets in Europe appear to be more attractive than those in the U.S.,” said spokesman Ricardo Duran.

For example in the first quarter, CalSTRS committed e100 million ($88.4 million) to Blackstone Real Estate Partners Europe V, according to the latest real estate activity report. Much like the pension fund is doing with its public equity portfolio, CalSTRS is selling U.S. assets to take on a more global profile with its real estate portfolio. The fund has a 13% real estate allocation; the split between U.S. and foreign could not be learned by press time.

There is a lot of real estate debt opportunity in Europe, especially originating new loans, said Park Madison's Ms. Lashine. Fewer European banks are actively offering real estate loans, and banks that are providing mortgages are more likely to lend on core real estate. And even then, most of the banks are only willing to lend up to 50% of the property's value, she said. “If you are a U.S. investor, you are used to getting close to 60% loan-to-value.”

The opportunity exists for real estate managers to provide mezzanine loans and to lend on less stable real estate, which is potentially more rewarding for investors, she said.

But not everyone agrees. J.P. Morgan's Mr. Valente said the real estate debt origination investment opportunity “is largely gone.”

“As the banks have returned to the market, those debt funds are becoming increasingly uncompetitive and are having to take on additional risk ... in order to generate the sort of returns promised to their investors,” he said.