by Jake Moeller.
Jake Moeller reviews highlights of a presentation by Andrew Hook, Fund Manager, at the Investment Week Property Breakfast Briefing, October 22, 2014.
The recent bout of market volatility is a salient reminder for all investors of the benefits of portfolio diversification. Direct property is well-known for its diversification benefits, but many U.K. investors in particular have a predilection to limiting themselves to U.K. property vehicles. Andrew Hook makes a convincing case for the inclusion of a European component, considering the real estate recovery evident throughout Europe despite stalling growth conditions.
Despite recent economic and financial gloom, Mr. Hook sees continued confidence in the Eurozone from 18 months ago. This has driven down peripheral countries’ bond yields from their recent highs, a reflection of investors’ trust in the ECB to manage the current situation.. He states that this is tempered by the weak September PMI data, meaning some further disappointment is likely for Q3 GDP numbers. He also recognises that deflation is a key risk, with six European countries in a deflationary environment, but he still sees much to be positive about in selected European property markets.
A turnaround in vacancy rates across European offices is evident, with Savills reporting aggregate take-up in the first quarter of 2014 of 3.9 million square meters and capital cities such as Dublin and Paris experiencing 58% and 24% increases, respectively, in year-on-year growth. Mr. Hook points out that there have now been five consecutive quarters when the average vacancy rate in Europe has fallen, and Aviva forecasts vacancy rates will decrease further until 2018, with a corresponding strengthening of the occupier market recovery taking place in 2017-2018.
Furthermore, Mr. Hook points to a benign supply side, with current European office additions (as a percentage of overall stock) below the 5% “replacement” level and only rising above this in 2017. That is well below the historical long-term average.
The fund currently sits around £230m in size, with 14 properties across 8 countries. Germany has been the country best represented geographically, with 48% of the portfolio invested here. One of the objectives of the fund is to “recycle” capital, taking advantage of favourable pricing conditions in Germany. Mr. Hook points out that prime office yields in London, Paris, Munich, and Hamburg have recovered from their cyclical lows in 2007 faster than in cities such as Dublin, and he is now looking to rotate some of the portfolio into Dublin offices and Swedish retail properties
Table 1. Three Year Performance of Aviva Investors European Property Fund v Lipper Classification. To End of September 2014 (in Euro).
There is currently 18% liquidity in the fund, 70 different tenants, and a 4.4-year average lease term (the average new lease term in Continental Europe is 5.0 years). The vacancy rate in the fund is comparatively high at 10.5%, but this is largely focused in a “strategic void” that has arisen because of some tenancy decisions and capital works largely in France and Finland. This should be reduced in the next reporting period of the fund.
Aviva Investors has modelled five-year potential total return forecasts from the European property (ex U.K.) market at 7% p.a. from June 2014. Given that forecasting is an imprecise science, Mr. Hook reminds investors that the European property market currently is not funded by large amounts of debt as it was in 2006-2007. Although deflation remains a risk, supply and demand dynamics are supportive and the asset class looks attractive from a relative pricing perspective.
Note update: December 9, 2015: In an update provided to Lipper, Aviva have made the following statement in relation to this fund:
“We can confirm the suspension of the Aviva Investors European Property Fund. This follows the largest investor indicating its intention to withdraw, which would considerably reduce the fund to a size that we do not believe is viable. As a result, and in the best interests of our investors, we plan to close the fund.
“Suspending dealing will enable the properties of the fund to be sold in an orderly manner, which will help to maximise the sales values achieved. Furthermore, suspension of dealing will ensure that, regardless of the size of their holding in the Fund, all investors will have access to the proceeds of their investment at the same time.”