News for the Hospitality Executive
By Howard Roth
February 15, 2013
As I am sure you know, 2012 was a year of continued challenges for global commercial real estate markets. Many economies are now slowly emerging from the Great Recession, but ongoing fiscal problems in Europe and a difficult political climate in the US have spurred uncertainty in the real estate world.
Yet, real estate investors have continued to find areas of opportunity. Indeed, capital interest in gateway cities has pushed pricing on transactions close to pre-recession levels – so much that some in the media are muttering the word “bubble.” But, also there has been a slow but steady return of the financing markets — specifically a revival in commercial mortgage-backed securities both here and abroad. The real estate investment trust (REIT) sector has expanded in the last 12 months in the US and key markets abroad, owing to accelerated REIT conversions and the potential for new IPOs. Finally, the US housing market reached bottom and has begun a slow but robust recovery.
All of these trends point to a market that is on the rebound both domestically and in key cities around the world. As usual, we’ve polled some of our resources in these markets and asked them to look into their crystal ball to see what ‘big picture’ stories we might be reading in 2013. You will find the highlights of their analyses below. I’ve also listed contact information for some of my global colleagues who are familiar with these topics through their work in the field every day. Please feel free to contact me or any of them for more insight.
I wish you a prosperous 2013.
Global Real Estate Leader, Ernst & Young
Investment capital seeks opportunity globally
Across the globe, a large amount of motivated institutional capital is pouring into gateway cities, like London, New York, San Francisco, Paris and Shanghai. The level of capital interest in these cities has driven yields for prime assets to near pre-financial crisis levels. The industry could see a noticeable increase in activity form large Chineseinvestors in particular, who are turning to the major global real estate markets as a way of diversifying their exposure. Over the last 12 months, they completed US$4.5 billion in cross-border deals, many of them direct investments, according to Real Capital Analytics.
The scale of institutional and foreign investor interest in the gateway cities has also encouraged lenders back into the market. Loan-to-value ratios are generally being capped at 60% to 70%; however, with the highly competitive US multifamily market being the notable exception. Because of the continuing gap in the debt markets, one trend that will likely continue in 2013 is the emergence of new lenders, such as sovereign wealth funds and insurance companies. Their focus will remain fixed on the primary markets, meaning deal volume and lending in secondary cities will continue to lag. Nevertheless, their engagement will help diversify the lending community, which will be especially important to global real estate funds with mandates to deploy capital but needing leverage to make the deals work.
Finally, the positive signs for a continuing recovery have also touched the long-troubled commercial mortgage-backed securities market. A number of major banks are hitting the US market with new issuances, though the estimated US$45 billion for 2012 is still small fraction of peak volume in 2007, meaning current volume will be unable to match upcoming maturities. Lenders and investors in the US and Europe alike will have to continue developing innovative work-out and write-down strategies through 2013.
Mike McNamara, Principal, Head of Real Estate Capital Markets, +1 202 327 6197
Real estate private equity funds confront ongoing challenges
Private equity fund sponsors will have a lot to think about in 2013. They are turning over a new year amid increased regulatory requirements instituted by Dodd-Frank and Europe’s Alternative Investment Fund Manager Directive (AIMFD), demand for greater transparency from investors, and lingering structural and cultural changes wrought by the recession. They should also anticipate continued challenges in deploying capital this year, following a slowdown in 2012 that touched even popular emerging markets like India and Brazil.
There are, however, bright spots on the horizon for the sector. In particular, a developing trend that is expected to deepen in 2013 is interest from sovereign wealth funds in setting up eitherjoint ventures or separate accounts with recognized global fund managers todeploy their substantial real estate allocations.
Mark Grinis, Global Real Estate Private Equity Fund Services Leader, +1 212 773 5148;
Ad Buisman, EMEIA Real Estate Leader, +31 88 407 9433
European investment funds face AIFMD compliance
Compliance with the European AIMFD will be a key issue for funds in 2013. The legislation, which goes into effect in July, was conceived to harmonize the regulatory requirements applicable to the managers of alternative investment funds, imposing substantially stricter requirements on conduct of business, remuneration and transparency. The directive is structured around two pan-European passport schemes – one to market alternative investment funds (AIFs) to professional investors and one to manage AIFs. It will affect European collective investment schemes and their managers, including real estate investment funds and some REITs.
Existing fund managers have until July 2014 to comply. Certainmanagers of fully invested or closed-ended vehicles may be exempt through grandfathering provisions. Also, non-EU-based managers marketing AIFs in the EU will be affected, but they will have until 2018 to obtain authorization as an AIFM under the new arrangements.
Most large managers have already begun their impact assessment and implementation programs. For those that have not, or which are just beginning to consider a compliance strategy, there are numerous pathways to meeting the directive’s requirements. These will be highly dependent on individual managers’ legacy products and structures, geographical footprints and future aspirations. It is therefore recommended that both EU and non-EU real estate fund managers first assess the directive’s impact on their investor demand, distribution strategy, products and organizational model before focusing oncompliance requirements and obtaining the licenses needed to operate in Europe.
Michael Hornsby, European Fund Leader, +352 42 124 8310
Non-traditional REITs gain momentum
The continued demand for income-producing assets in today’s economy means that more businesses with substantial real estate holdings will explore the option of forming REITs in 2013 as a way of creating value for their shareholders.
In 2012, instances of businesses seeking private letter rulings from the IRS gained considerable traction. Numerous factors fed this trend, such as the REIT structure’s reliable income stream, low cost of capital and not least, the market’s highly favorable attitude to them. REITs have not only outperformed the S&P 500 index for the last five years, but more interestingly, the market has even been rewarding companies considering REIT conversion with stock price bumps of 25% on average. REITs have also gained popularity among pension funds and endowments, which are now committing 7% to 10% of their capital to these investments, compared to historical levels of 5% to 7%.
All of these factors have encouraged companies from a range of industries, including timber, gaming and health care companies, as well as cell tower operators and data storage providers, to approach the IRS for private letter rulings. This key to whether this trend continues through this year will be the IRS’s willingness to issue them.
Mike Straneva, Americas Director of Real Estate, +1 602 322 3610
Housing: recovering sector tests new vehicles
The distressed play in US housing markets is largely over, but investor opportunity certainly is not. The sector’s recovery still has a long way to go.
On the development front, equity is plentiful but private builders still face a tremendous gap in the debt markets. There is therefore a huge opportunity for specialty finance companies or mortgage REITs to fund development and construction. Those that do will likely be very conservative in their underwriting, but spreads will be very attractive.
This year will also be a significant test to the “rent-to-buy” strategy, which gained traction among a number of large funds. Demand for single-family homes is beginning to climb again, primarily from over-65s trading down and first-time buyers coming back to the market.Indeed, with home sales projected to top 800,000 homes in 2014, a big question mark hangs over how successful 2012’s large-scale distressed buyers will be in profitably managing and operating their portfolios.
Steve Friedman, National Director, Homebuilding Services, +1 202 327 6219
Hotels: branding takes hold in emerging markets
Internationally recognized hotel brands andoperators are catching on in emerging markets, especially Brazil and China,where hospitality owners are affiliating with them as a means to maximizingreal estate value and capitalizing on growth in domestic wealth and economic globalization.
In China, where government policy heavily affects new development projects, developers are often required to include a luxury hotel component in plans for large mixed-use projects before they can purchase land. Globally recognized hotel brands are therefore being used toraise the profile of the larger project. Supply in the hospitality sector in China, however, greatly outpaces demand, which makes it difficult for brands to grow these assets under management.
In Brazil, the opposite case is true: occupancy and room rates run high across the sector because hotel supply is far belowcurrent demand. The supply-demand imbalance is the result of a lack of desirable development land and lengthy approval processes. This has led to a divergence in brand focus between hotel developers in Brazil’s primary and secondary markets. In the top cities of São Paulo and Rio de Janeiro, hospitality owners continue to target higher-end brands whereas in secondary markets, investors and developers aim more for mid-scale brands.
Brian Tress, Northeast Area Leader, Hospitality & Leisure Services, +1 212 773 8359
About Ernst & Young’s Global Real Estate Center
Today’s real estate industry must adopt new approaches to address regulatory requirements and financial risks, while meeting the challenges of expandingglobally and achieving sustainable growth. Ernst & Young’s Global Real Estate Center brings together a worldwide team of professionals to help youachieve your potential — a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately it enables us to help you meet yourgoals and compete more effectively. It’s how Ernst & Young makes a difference.
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