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Big money is burning a big, big hole in the pockets of private equity funds, and they want to spend it on real estate. It could mean a big surge in 2021 refurbishment work at a time when mainstream developers are sitting on their hands.
Words: David Thame
How come? Here’s how. Private equity has raised billions from high-net-worth individuals, who are finding it hard to make their money work for them. The 10 largest have raked in $450 billion in the last six years according to data from Statista. Blackstone (the daddy of them all) raised a cool $96 billion on its own.
Why are the taps on? Because stock markets are too volatile, interest rates are too low, and whilst buying government gilts is at least safe, negative yields mean it is very expensive. Everyone fears the economy is about to take a dip (a recession was overdue before coronavirus) and only a fool buys gold. This all adds up to a problem for the cash-rich who are handing their money over to private equity firms who invest in high growth businesses, and in particular in the ever-safe option of real estate. Yes, it’s a bit riskier, but it promises much better returns. And if you pick your private equity real estate fund carefully, the risks are carefully calibrated.
The private equity guiding rule is buying low, sprucing up the look and the tenant mix, and selling high. This means their real estate funds often work counter-cyclically, buying and refurbishing when the property market is on the floor and selling newly improved asset- managed properties back to more cautious investors as the economy begins to lift off the canvas.
Today, Knight Frank guestimates that as much as £1.25 billion of private equity funding is hunting in Birmingham’s office core, at least as much in Manchester and, across the UK office markets, the sums mount up into tens of billions. Something similar is happening in the student housing, leisure and (mad though it may seem, with the high street looking dead) retail sectors.
Birmingham-based regional property investor, Colmore Capital, is an increasingly big fish in the pond of UK regional private equity. In the last few weeks of 2020 it expanded its portfolio with the acquisition of the 16-acre Wavendon Business Park from M&G for around £20 million, and was brewing two further buys of £50 million and £100 million respectively.
Colmore Capital Founder, David Corridan, explains why acquiring the 148,000 sq ft Grade A office park in Milton Keynes is perfect for what he is trying to do.
‘The Wavendon site is a perfect example of an environment that should prove extremely attractive for a return to the office, and an end to working from home,’ he says. ‘There’s seven or eight angles to this, the first being to make sure there’s adequate car parking. But the site also needs green spaces and biodiversity and, at least, the level of amenity people get at home. After a year of homeworking, nobody is going to want to be far from a fridge, or a good interesting place to have lunch, and basically this has to be a pleasant place to exist in.’
Colmore, who bought the property from a major fund, will asset-manage and improve the site and then, in four or five years (or less, or more) sell it on, probably to another big fund.
And for private equity operators like David, the bigger the refurbishment project the better, within reason. ‘We want to be able to produce property assets that we think will appeal to, and sell to, the broadest range of investors possible – because those investors themselves think about how saleable the assets will be for them, too. And, typically, that means a more wholescale refurbishment than something light touch, which will not produce the kind of asset that works today.’
The kind of big interventions David likes produce an element of ‘wow factor’ along with a genuine amenity that cheers people up: roof gardens are a particular favourite, and he cheerfully admits to installing them wherever possible.
It all adds up to counter-cyclical investment and development. ‘That’s certainly the aim,’ says David. ‘If we can find the right buildings to buy.’
This is where the story of private equity involvement in the 2021 office market gets complicated, because the weight of money looking to buy into UK real estate is vastly greater than the limited volume of buying opportunities coming to the market.
Two factors are worth noting. First, most potential vendors are not yet distress sellers. So they prefer to sit on their hands, if they can, and wait for property values to recover rather than sell at today’s lowish prices. Excitement about a coronavirus vaccine gives them additional reasons not to sell today, hoping for a return to some kind of ‘normal’ life in early 2021.
Second, simple market logic dictates that, if you have a lot of money chasing relatively little in the way of potential product, then prices go up. So far there isn’t much evidence of actual price rises but there is evidence that the sale prices of useful UK office stock are holding up very well indeed. Two deals prove the point.
Germany’s Union Investments bought Birmingham’s 55 Colmore Row for £100 million, a yield close to 4.5%, whilst Helical sold a portfolio of Manchester office blocks to private equity funds managed by Pictet Alternative Advisors, S.A. and XLB Property Limited for £119 million, a yield of 5.2%. In both cases, those are hot yields.
Jason Winfield is Head of UK Capital Markets for Business Space at consultants Cushman & Wakefield. He agrees that private equity and their core-plus and value-add funds are looking for places to spend the upwards of £85 billion they raised in the last year, enough to buy every property on the London market twice over.
There will come a change. Banks will begin to foreclose on property loans. That’s when vendors will have to sell and private equity comes into its own
The difficulty, he says, is the rather impressive yields recorded in the Manchester and Birmingham deals. So long as private equity is telling its investors it can secure 10-15% returns, fund managers need to do their maths carefully when buying assets. Yields of 4-5% are just too keen and their maths won’t work. The price is simply too high.
‘We don’t yet have sufficient distress in the market for vendors to let the price drop to the clearing price that begins to attract private equity. Regional offices offer private equity great opportunities, but vendors just aren’t yet in sufficient distress to sell, and the approach of a vaccine makes them even more reluctant to sell,’ Jason says.
For now, Jason agrees that the private equity real estate scene is like a well-shaken bottle of Champagne. There is plenty of cash to spray around once the cork has been popped. And that depends on vendors deciding to sell office buildings at prices that work for private equities’ elevated view of potential returns.
‘There will come a change. Banks will begin to foreclose on property loans. That’s when vendors will have to sell and private equity comes into its own. But even here it won’t be a flood because interest rates are low, most borrowers are not heavily leveraged, unlike in 2008-12, and so the opportunities to foreclose are fewer.’
‘The result is a hell of a lot of money waiting for opportunities that may never materialise,’ says Jason. Private equities’ hopes of deploying some of its capital reserves in real estate depend on high-level economic variables like Brexit and vaccines, and low level calculations like how soon banks get fed up with bad loans and how much appetite they have for solving the problem by foreclosing.
The difficulty for private equity is knowing when to call the bottom of the market, which is the moment they move into action.
‘I think the private equity markets expect the economy to deteriorate before it improves. They think there will be a hell of a lot of opportunities next year, but I wonder where?’ says a puzzled Winfield.
Many observers say that, by Q2 2021, economic distress will be higher, meaning property prices are lower. At which point some of the people who have been putting money into private equity funds – and watching it go nowhere – may decide to start direct property investment on their own accounts. This could help fire up the market.
2021 is going to be a tricky year in the office market, and it will need all the friends it can find. Private equity could – if the cards fall in the right places – turn out to be one of the best.
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