These are turbulent times for the eurozone and its currency. When Greece, a euro member, plunged into crisis in 2010, the euro started to lose value – first slowly, but then very rapidly from the middle of 2014. By comparison with the exchange rate at the beginning of 2014, the euro has lost almost one-fifth of its value against the US dollar and around one-tenth against the British pound. In early July 2015, the single currency was trading at just over 1.10 US dollars. In March of the same year, the rate was actually only slightly above the significant 1 US dollar mark. However, the Greek crisis is not the decisive reason for the weak euro. The key factors, says Eric Heymann, an expert at Deutsche Bank Research, are “the expansionary monetary policy of the European Central Bank” (ECB) and “expected differences in interest and growth rates between the USA and Euroland”. In March 2015, the ECB started buying bonds worth €60 billion each month so as to pump fresh money into the markets at least until September 2016, and keep the level of interest rates in the eurozone low in an effort to stimulate economic growth.
In the USA, by contrast, the key interest rate is expected to be raised as early as this autumn, because the economy and especially the labour market are developing very positively. However, what does it mean for real estate asset managers that one euro is now worth only 80 US cents or 90 British pence – at least, as measured against the position at the beginning of 2014? And what impact do foreign-exchange losses have on the performance of a real estate fund? Manfred Binsfeld, Head of Real Estate Research at Feri Eurorating Services, believes the direct consequences are very clear: “Since property investments are long-term in nature, short-term exchange rate movements tend to play a minor part in the decision-making process.” The most important factor, the expert explains, is the fundamental economic prospects of a given country. These include points such as demographic trends, the country’s economic growth and its potential for innovation, as well as its labour market and income development. Of course, investors also assess each country’s monetary and financial policy – in other words, the prospects for inflation and interest rates. “Countries that are successful in these areas and will probably remain so in the future have strong currencies. For this reason, it is no wonder that the dollar and the pound have been appreciating against the euro for a long time,” Binsfeld says.
Currency positions are hedged
However, this does not mean that real estate asset managers are ignoring foreign-exchange risks. “Major international investors with global portfolios use skilful diversification and hedging strategies to counter volatile exchange rates,” explains the Feri expert. This applies, among others, to German open-ended real estate funds. “They largely go about their business using the same currency,” says Sonja Knorr, Director Real Estate at the German ratings agency Scope, explaining: “At fund level, foreign-exchange risks are generally hedged through forward exchange contracts with differing terms.” A similar function can also be performed by a loan in the relevant national currency, which finances a proportion of the purchase price. Since payments of interest and principal are made in the national currency, the loan serves as a natural safeguard against exchange-rate fluctuations. The same applies to rent payments, she notes. Only in exceptional cases – for instance, EU member states outside the eurozone, such as Poland or the Czech Republic – do tenants pay in euros. “We have observed that, for most German open-ended real estate funds, more than 99 percent of currency positions are hedged,” the analyst Sonja Knorr comments. For this reason, she goes on to give the all-clear: “If anything, exchange-rate fluctuations have only a very small impact on performance.” Hedging, or limiting, foreign-exchange risks is also essential for institutional investors such as insurers or pension funds when they put money into property, says Marcus Cieleback, Head of Research at the listed real estate company Patrizia. “However, the greater the volatility – meaning the fluctuation range – of a currency, the more expensive exchange-rate hedging will be,” he explains.
Exchange-rate fluctuations have only a very small impact on fund performance.
In this roundabout way, he says, the weakness of the euro does still affect investors from the single currency zone. Since purchases have at least the same yield requirements for investments abroad as for investments at home, they could pass the cost-effectiveness test but still fall at the hurdle of excessive hedging costs. There is one other area where property investors feel the effects of the weak euro indirectly. “The competitive climate is far less favourable for domestic investors than it is for investors from abroad,” says Marc Balkenhol, Chief Operating Officer at the Munich-based IC Group. With €10 billion of managed assets, it is one of the country’s largest asset and property managers, and around 60 percent of its customers come from abroad. “As a result of the depreciation of the euro – or, conversely, the appreciation of other currencies – foreign investors are suddenly getting more real estate for their money,” explains Balkenhol.
Accordingly, they are willing to pay higher prices in euros, with which domestic investors can no longer compete. He notes that this applies, for example, to the Americans, the British and also the Swiss. The impact is seen clearly in the German commercial real estate investment market. It attracted €24 billion in the first half of 2015. This is 42 percent more than in the same period last year, according to an analysis by the international commercial real estate advisor CBRE. Out of the total volume, 57 percent came from foreign investors. As of mid-2014, their share was about 48 percent. North Americans formed the largest group. They bought buildings worth more than €5.5 billion with their strong US or Canadian dollars. Subsequently, prices rose and yields fell – to a mere 4 percent for prime office properties in Munich, for example. “Investors from other currency zones are now making purchases at initial net yields which a few years ago were regarded as absolutely inadequate,” says the IC Executive Board member Balkenhol.
Conversely, investors from the eurozone are naturally finding things harder outside their currency area. In London, for example, the prices of office properties have more than doubled since 2009, when the market hit its lowest point. At the same time, the British currency has gained a good 20 percent. The Feri expert Binsfeld puts it this way: “This means that, at present, real estate in London is cyclically expensive for investors from eurozone countries in two respects.” However, in the current market situation, which is characterised by high liquidity and extremely low interest rates, globally positioned property investors simply have no alternative. “They have to seek safe investment havens,” Binsfeld says. In addition to Germany, these include Britain itself and, especially, the USA. For this reason, Binsfeld does not expect the appreciation of the US dollar to put eurozone investors off that huge market on the other side of the Atlantic: “The dollar would have to move a lot further away from its fair value than it has done before international investors start shunning the growth market in the USA.”