Europeans shift US tactics as yields shrink

Real Estate Alert, April 21, 2004

European investors, increasingly shut out of buying opportunities because of record-low initial yields, are changing their strategies in the U.S.

Some $4.3 billion of large office and retail properties were acquired by European investors in 2003, down from roughly $4.5 billion in 2002, according to Real Estate Alert's Deal Database, which tracks transactions of $25 million or more (see list of European investors on Pages 11-13).

The drop in activity was not for a lack of trying. Indeed, interest among investors has never been higher. Operators of German closed-end funds may have raised more money last year for U.S. properties than German real estate. Outside of Germany, players such as British investor Strategic Real Estate Advisors and HDG Mansur, which is backed by investors from Europe and elsewhere, were particularly active buyers.

But European players increasingly were outbid on office properties in markets where they have traditionally been active, such as New York and Washington. In those areas, core properties are now frequently trading at prices that translate into initial yields of less than 7%--a line many European investors, especially German fund operators, don't want to cross. The 7% threshold is also being breached in a handful of other office markets nationwide, while the 6% level has been increasingly broken in the mall market.

The declining yields have forced European players to pursue opportunities and markets previously avoided. For example, RFR Realty, which is backed by German investors, has made a conscious effort to move beyond its traditional base of conservative New York office purchases to target "value-added" plays. Last month, it teamed with New York player Sutton East to pay $240.5 million for Desert Passage, an underperforming mall on the Las Vegas strip.

Similarly, Jamestown, the giant German closed-end-fund operator, plans to launch later this year a core-plus/value-added fund series, dubbed "Jamestown Plus." Vehicles in the new series will take on smaller properties with upside potential.

Even with its current closed-end fund, Jamestown departed from its traditional conservative office mold, buying a 60% stake in a South Florida hotel, as well as a San Francisco mixed-use property that includes hotel space and a development parcel. Future Jamestown funds will also look at hotels, said Stephen Z0ukis, a partner with the Atlanta-based company. "While we've bought core properties for several years, our mandate is not to buy core. It's to achieve a certain yield," Zoukis said. "Markets change, and you have to adjust your focus to respond."

European investors are making other unusual plays to capture higher yields. In what may be a first, RFR plans to flip one of two Wall Street office buildings that it is under contract to buy from a German fund. And in another twist, RFR may convert the other building for residential use.

In another break from the past, German fund operator IGB (Internationale Grundwert Beteiligungs) hopes to launch a fund that will develop properties. Joerg Kanebley, who heads IGB, plans to come to the U.S. next month with hopes of reviving talks with Republic Properties, a Washington developer seeking an equity partner for Republic Square, a planned 567,000-sf office complex at Massachusetts Avenue NW and North Capitol Street in Washington. IGB last year discussed taking a 50% stake in the project, in what would be the fund's first U.S. investment.

European investors last year continued to broaden their focus beyond their traditional "Big Six" markets: Atlanta, Boston, Chicago, Miami, New York and Washington. They now are just as likely to pursue opportunities in such locations as Los Angeles, Seattle, Las Vegas and Central Florida.

European players need to go into other markets to achieve yield targets, said Siegfried Fernitz, director of Greenwich Group International's Frankfurt office. Investors "are expecting a return of 7.5%-8%, because they are used to seeing those returns."

For example, Stichting Pensioenfonds ABP, a pension plan representing Dutch civil workers, formed an ongoing joint venture in October with Prenliss Properties, a Dallas REIT, that could ultimately buy $510 million of U.S. properties. It will target Class-A offices in Prentiss' core markets: Chicago, Dallas, Northern and Southern California, and the Washington metropolitan area. Prentiss will hold a 51% stake in the properties acquired. The buzz is that the joint venture is paying $124 million for Cityplace, a Dallas tower that serves as the headquarters for 7-Eleven. Previously, Prentiss was identified as the winning bidder for the 1.4 million-sf building.