The low-interest-rate environment and lack of investment alternatives have driven many institutional investors into the asset class of real estate in recent years. But high demand leads to a problem: security-oriented investors are not inclined to take risks when investing their assets, but have to generate a sufficient yield at the same time. Yet that is barely possible. Continued demand for modern commercial properties in prime locations with tenants backed by a strong credit rating has often pushed yields below the 4-percent level. The potential for setbacks if interest rates start to rise again is steadily forcing investors to seek alternative investment strategies. It is therefore imperative that Europeans be more open to risk in order to achieve appropriate yields. But should a higher yield be bought through poor locations or inferior building quality? For long-term conservative investors, and we include ourselves among that group, this is certainly not a feasible option.
Yet there are strategies for securing both quality and yield even in periods of high price levels. One such strategy is project purchases or equity financing of development projects. The investor identifies the real estate developments of third parties and purchases them at an early development or construction stage. The asking price is paid either as building progresses (forward funding) or following completion (forward purchase). There are two chief advantages over the purchase of a finished property: first, the investor can feed in their standards during the negotiation, examination and supervision of the project. These transactions are not usually subject to the competitive and time pressures that often accompany bidding wars for finished buildings. Second, the achievable yields are higher – at least half a percentage point more per year should be generated. We have demonstrated how successful this approach can be in recent years – and thus created a key performance lever for our funds. Of the 26 purchases in 2012, eleven were development projects – equivalent to a share of some 42 percent. We continued this strategy consistently in 2013, securing another eleven properties at the project stage in Europe.
Current examples include the new MainTor Porta office building in Frankfurt am Main, which is being developed by DIC Deutsche Immobilien Chancen until mid-2014, and the first office and business centre in the new Munich urban quarter, Am Hirschgarten, realised by Hochtief Projektentwicklung. As early as 2011 we secured an option to purchase the first Motel One hotel in Brussels. The hotel project, for which a long-term lease was secured in advance, will be completed this year. We have also had good experiences with project purchases in both Helsinki und Amsterdam in recent years, working well with such knowledgeable developers as NCC and Dura Vermeer: the Stibbe law firm’s new office in the Zuidas Amsterdam office district, now at the project stage, is the latest proof. Yet in spite of these success stories, the higher risks involved in project purchases should not be overlooked either.
Whilst the typical project risks – planning mistakes, overruns in construction and thus rising costs – may still be borne by the project developer, the investor must often be willing to carry some of the risks involved, especially as regards the property’s late letting. Apart from the ability to assess a building not yet finished and at least to supervise the construction process from the investor’s perspective, they should also be able to forecast whether the building, or unoccupied space within it, can be let at the prices originally estimated. Potentially they must even be capable of completing the project and the letting process themselves. This know-how, which keeps the risks taken on manageable, is held by very few investors.