Sure, commercial real estate is a complex business here in the United States, but try taking a shot at Europe. While the European Union [EU] does provide a common thread and open up borders, it can also create a politically tense climate with so many nations’ disparate interests tied closely together. Then, there’s the euro zone, the 12 countries — excluding Great Britain, Denmark and a handful of others — where the euro is taking hold as the dominant currency. In and of itself, the euro can be a political hot potato. Follow that up with language and cultural differences developed over millennia, and, well, let’s just say Europe isn’t for the faint of heart.
But a few companies have mastered the Old World, among them Insignia Financial Group through its London-based subsidiary Insignia Richard Ellis, which Insignia acquired in 1998. The combined companies have taken a dominant position in London — a 25% marketshare for Central London lettings and a 36% share for investment transactions — and established a base across Europe, with a presence in Paris and Madrid, Spain, on the horizon.
Post-MIPIM, the international real estate conference held every year in Cannes, France, NREI caught up with two of the rudders of Insignia’s European operations, Stuart Eisenkraft, executive director of international client services, who’s based in New York, and Stephen Hubbard, deputy chairman of Insignia Richard Ellis, who’s based in London.
NREI: How is the European Union’s emergence affecting European investment markets?
Stephen Hubbard: The European Union has been around for a long time. The issue that has changed in the past 18 months is the introduction of the euro. I think it’s had a positive impact generally on cross-border investment activity in the euro zone in Europe, principally because it takes out currency risk, which was one of the big unknowns in terms of investing around Europe. Albeit, the currencies to some extent were linked together, but there was a lot of fluctuation, particularly with the Italian lira.
It’s an issue that affected the U.K. market and pound, because the pound probably has shown more characteristics similar to the dollar than it has to the euro over the past 18 months. The economy in the United Kingdom is more on track with the U.S. economy than it is with the European economies.
Broadly, with the big powerhouse investment firms, especially with a lot of money coming out of Germany, perhaps more has been invested in the mainland European markets than had previously been the case.
NREI: What are some of the hurdles your clients face in international expansion, and how do you help them overcome those hurdles?
Stuart Eisenkraft: On the corporate end-user side, clients really have to differentiate between the markets, not only on the property side but also on a lot of the critical lead economic indicators and demographics because property tends to be the tail wagging the dog.
Our corporate services group out of our West End offices really looks at language barriers. They’re looking at the available stock, not just in real estate product and its vintage and ability to handle sophisticated requirements or research requirements or general office requirements. They’re also looking at the employee base, the housing availability, corporate taxation base, the mean age of that employment base and the associated wage contours. It doesn’t help if you can find a suitable business park or a suitable office block in a city where you can’t hire employees under the pro forma that they require or where they don’t have enough language skills — be it a call center or sales and marketing organization or banking organization, because we are talking about the European Community. A lot of these elements really are the cutting edge of a property search, not the property.
Hubbard: One other big issue, which is bigger now than it has been in the past, is employment law. The EU has developed employment law regulations that many European countries have adopted and has become very employee-friendly by giving workers rights in terms of not only managing the business, but also in terms of employment security. This has become quite a major issue with the "new economy" industries coming into Europe that want a more flexible workforce to go up and down with supply and demand.
Probably, the U.K. benefited the most from that, as its employment laws perhaps are more akin to those in the States. The U.K. has the right under the EU treaty that we signed to actually step out of the employment law restraints that are present in many of the mainland European countries.
Eisenkraft: If you look at and track the inward investment in these countries, you see how much the U.K. has benefited and how much Ireland and Scotland and Wales have benefited in proportion to the rest of the continent. What Stephen is saying is, it’s not only ease of entrance, but it’s ease of exit as well.
In France, if you hire someone, you’re going to be paying them severance. I believe [severance] is 18 to 24 months on a graduated scale downwards.
Hubbard: In Holland it’s pretty similar to the U.K.
It is a factor, it’s not just the U.K. There are friendlier environments for employment law, and I think it’s becoming an increasingly important issue in terms of relocation.
NREI: With many U.S. markets basically at their peak and the U.S. economy sliding a bit, what are some of the better investment opportunities in Europe?
Hubbard: Certainly we’re seeing an increasing flow of interest and, indeed, money coming from the U.S. into Europe. It’s probably at a fairly early stage.
The first stop tends to be the U.K. Obviously, the basis of the market and the language makes it a friendlier location to start. Although it’s becoming a little clearer at the moment, nobody’s quite sure what point the U.K. market is at. But the fundamental issue with the U.K. investment market, which has tended to be an attraction, is that typically most tenants are actually occupying buildings under a 15- to 20-year lease, which cannot be broken, with the tenant responsible for all operating costs. So you get triple-net income.
That has been the market that has developed with the U.K. institutions and pension funds at the core of the development of that marketplace. Therefore, it’s a friendly market for overseas institutions to come in and participate, because it fulfills many of their objectives in terms of risk/reward in property investment.
There’s quite a lot of activity with groups like Teachers (Insurance and Annuity Association) investing quite heavily here in the U.K. and now expanding their portfolios into mainland Europe.
You’ve then got a lot of the opportunity players who’ve set up operations here in London to service all of Europe. People like Blackstone, J.R. Roberts, etc. have quite sizable operations here. Initially, investors with some of the opportunity funds were coming over here and targeting quite unrealistically high internal rates of return, which were not sustainable in mature markets. They then aggressively targeted the Central and Eastern European markets, which carry a tremendous amount of risk. Most European investors were keeping quite a bit of distance from those markets. The interest in Central Europe has subsided over the past 18 months, and the core activities of overseas investors from the States basically has centered into France, the U.K., and, to a lesser extent, Germany, Spain and Italy.
NREI: Is Eastern Europe still a bit too risky for most?
Hubbard: For the institutions, it’s way too risky. Those who’ve looked at it — and some have actually put their toe in the water — haven’t seen the anticipated returns delivered in many instances because of the volatility of the markets over there. Money going into those markets now is at a fairly subdued level. But it’s coming more from the opportunity funds than from institutions.
NREI: How are European property owners reacting to tenants’ needs for more flexibility? How do you reach common ground?
Hubbard: The issue we have in all European markets, which I think is characterized in the States as well, is that you have an acute shortage of supply. Generally, vacancy rates are at an all-time low in most of the marketplace. With the current downturn, that might change, and things might change a bit in the course of the next 12 months compared with the past 12. It’s basically been a landlords’ market. Tenants’ requirements for flexibility in such a market have not been met. The landlords have not deemed that it’s in their interest to provide it, so that’s not the way the space has been let. If [tenants] have flexibility in their lease, then they have to pay for it.
Eisenkraft: Or secure it with a triple-A covenant.
Hubbard: We’ve had some pretty unusual market conditions. Generally most markets have unhealthily low vacancy rates. Actually, it’s odd that everyone last year said we can’t carry on like this and we need to slow down. Otherwise, the whole thing is going to implode.
Now, we’re actually having the slowdown and everybody’s worried about that. Certainly in most of the prime European markets, the growth and demand last year was unsustainable. As the markets become more balanced, we’ll see flexibility in leases and flexibility in terms of covenant strengths that will return to perhaps a more realistic level.
Eisenkraft: You’ll be able to discuss more flexible options in negotiations. There are a couple of aspects here with high-tech tenants. If you’re talking about dot-coms, there really wasn’t the type of flexibility on staging a lease term as you might think there would be in the United States in certain markets.
Clearly in New York that flexibility didn’t exist either because there was such acute demand. They paid top dollar and entered into 10- to 15-year leases. There was no alternative.
In terms of your telecom or data center or data storage-type tenant, they actually wanted the longest leases that they could get because of the capital investment in the premises as well as trade agreements they had entered into with their clients. The contract provisions run into problems in some places where the Napoleonic Code is in place, as opposed to common law and the Germanic Code, because the leases are typically done in a three-, six-, nine-[year period], with breaks after three, breaks after six or breaks after nine. You can do a straight nine-year lease, but you’d find that, in doing such transactions, you might bring in somebody from Stephen’s investment group to establish a credit bail [similar to a credit lease in the United States] and look at the tax ramifications on the tenant’s balance sheet. You’re going outside the box and not doing just a straight lease.
As far as corporate end-users, Stephen hit it on the head. Everybody would like to have flexibility because strategic planning is for five- and 10-year tranches, but it rarely ever goes beyond 36 to 48 months because the world evolves outside of the plan. Tenants have not been able to get that kind of flexibility in a market where demand is so grossly out of equilibrium with supply.
NREI: So how do you put together deals for a large, corporate, high-tech client such as, for example, an Oracle or Cisco, for example?
Hubbard: Basically, they’ve had to lock in long-term commitments and have managed to, perhaps, get more flexibility in their leases because of the quality of their covenant and the quality of their offer as opposed to XYZ.com.
If you’re building up a big business park and you can get a Microsoft or an Oracle in there as a big user, it adds quality to the tenant profile of the business park and has other ramifications, a bit like having an anchor tenant in a shopping center.
Many of them have been able to benefit from that status, but maybe that’s by getting a break at the 10th or 15th year. It’s no big deal. But also one tends to find that with those large occupiers, there’s a great deal of cash going into the investment that they put into new operations and new buildings, particularly with the technology these days. They tend to want to stay there for a 10-year period anyway rather than move out earlier. Flexibility for bigger tenants hasn’t been such a big issue.
Eisenkraft: The big issue that we’re running into in the United States and increasingly in Europe is: How is a tenant like that going to lease space with zero-cost infrastructure? We’re talking about a tenant who is maybe a new-technology firm with funding in place up until 2003 and a transparent revenue stream and that may need to do some refinancing. That is going to be one of the issues that landlords are going to have to make very strict judgments on.
Who’s going to live a long life? Who’s going to be able to support their existing funding? Who will [landlords] capitalize infrastructure and tenant build-out with going forward? That’s something we’re grappling with in the United States right now. It’s going to be a challenge for landlords, and it’s going to be a challenge for our community.
Of course, energy is the next issue.
NREI: Is that becoming as big a concern in Europe as it is in parts of the United States?
Hubbard: No, not really. We have the energy. We don’t necessarily have it in the right place. If you look at London, for example, and big areas of regeneration like Paddington where a lot of development is on expelled railway land, etc., it doesn’t have the power infrastructure. It’s been quite expensive in terms of bringing that power into that location. Generally, we don’t actually have the shortage of power that you’ve got in the states on the West Coast.
Eisenkraft: Another issue that should be brought to bear is that we are not as ecologically minded as the Europeans, especially with our new president. Another phenomenon that we’re going to be dealing with, specifically on the technology and telecom side, is that there’s going to be a crackdown in the European Community and in European countries on all these generators that are installed so that tenants have six-sigma resiliency. Europeans are much more aware of pollution and noise abatement than we are.
Power will become a problem as the Internet grows and the volume grows. There’s a new customer every 4.5 seconds on the World Wide Web. That’s going to create demand, and the data going across is huge. Power will be an issue. Regulation in the European Community is probably going to be a bit smarter than deregulation in the United States.