By: Omar Khattaly
Researcher & Consultant on MENA Political Economy and Sovereign Wealth Funds
March 2014
How will the global CRE market expected to perform in the short term? According to Jones Lang LaSalle, 2014 will create new records. The overall investment picture is appealing with a rise in investor confidence and an increase in competition for core assets in core locations. This will, in turn, push down yields and drive investor appetite up the risk curve. In 2014, investment transactions estimated to be in the range of $525-575 billion.
2013, was definitely a year of impressive growth, over $500 billion in CRE transactions, corporate balance sheets are looking great, stock markets in major financial center have closed the year with a big plus, and Europe seems to be on track to come out of its recession and Asia Pacific region is maintaining its growth. Globally, third Quarter 2013 results are 16% ahead of second quarter 2013 results. When compared to 2012 results, activities through the end of the third Quarter are up 21%, $366 billion vs. $301 billion.
The report estimates the U.S. real estate market, the world’s largest, will grow 10-15% in 2014. Q3 2013 U.S. investment volume was $55 billion; this was the first time since 2007 that quarterly volume has passed $50 billion.
Investor demand in the U.S. market remains strong, especially in the core market. Office sector led the growth with a sales volume increase of 32% over previous years. This growth mainly credited to the availability of money and low interest rates in the market. Secondary markets in the U.S., such as Atlanta, have contributed to this growth, where investors are starting to look for better yields outside the heavily competitive primary markets.
The graph below provides a clear picture of quarterly activity over the last 6 years. 2013 will finish about 33% lower than the peak of 2007, which was $758 billion in total transactions globally. The global market is recovering at an impressive and steady rate.
Asia-Pacific had a strong 2013 with transactions reaching $120 billion. This growth will continue into 2014 with an anticipated increase to $130 billion. Most of the growth in this region is being driven by Japan, Australia, China and Singapore. Primarily offshore groups drive the growth in Australia and China. Reports indicate this region will break new records in 2014.
Europe will continue to grow by 5-10% in 2014, with most of the growth coming from UK, Germany, and France, but with some contributions from markets in central and southern Europe. Countries such as Poland, Spain and Netherlands will see much growth and bring more investor focus.
The following chart shows the largest markets and their growth in 2012-2013. This gives an indication where the market may be heading in the years ahead.
It is my opinion that 2014 will not be as strong as 2007, but we should expect a very busy year all over the globe. The U.S market will continue its growth from private and public investors. The office sector will continue its rise and industrial and logistics sector will see great growth especially in the areas of the East Coast and the Gulf Coast. The completion of the Panama Canal expansion, which is set to be completed in 2015-2016, will affect the growth of this market tremendously. Demand will come in from retail and manufacturing. I think cap rates and yields will be suppressed and with it we will see some outflow of capital from key primary markets in the U.S to smaller secondary markets. I think we will see this trend happening in many of the key developed countries all over the world, where investors’ demand for core plus properties is pushing the availability down and with it the cap rate and yield.
We will continue to see the flow of capital from the MENA region and China into the European markets, especially London which is considered a safe Haven for money coming from those regions. I strongly believe that the highest yield in the CRE market in 2014 will come in from secondary markets in Asia (India, Vietnam, Laos, and Malaysia, and Indonesia), and in Latin America (Brazil, Chile, and Colombia). Colombia was chosen as the number one destination for FDI in 2014 by the Foreign Direct investment institute.
Africa will be another hot market for many investors with a strong appetite for risk and higher yields. South Africa will continue to be a favorite for many but investors should also consider countries within the continent, which have begun to show high levels of economic and political stability. These countries include Ghana, Kenya, Nigeria, Botswana, Uganda, Angola, Namibia and Mozambique.
For those with a low appetite for risk, Europe will always be a great market. CRE will continue its upward steam in 2014 but with a lower yield in primary markets. It will be difficult to find core and core plus properties in key capitals, such as London, Frankfurt, Berlin, and Paris, but there will be plenty to shop for in secondary markets such as Manchester, Birmingham, and in Countries in Eastern and Southern Europe.
Can the Libyan Investment Authority (LIA) be a strong player in this $500 billion a year market? The answer is yes.
LIA Real Estate & Hotel Fund how, where, and when
The LIA Real Estate & Hotel fund has been set up; however, now the fund provides limited access and assets are scattered. The Real Estate Department should be responsible for reviewing and analyzing investment proposals and for executing, monitoring and managing investments, which is not the case now.
This section of the study will provide a proposed plan to better manage and invest asset.
Which Region or Geographic area should LIA focus on?
In a 2013 year end survey study by Colliers International, one of the world’s leading real estate services company, it was a surprise to many that out of 520 investors from all over the world about 70%-90% of those surveyed stated that they would invest within their local markets first and then expand to other regions.
LIA’s focus should be prioritized on (1) Libya, (2) Europe and (3) the U.S. LIA, will need to concurrently address existing assets in Africa. In a time of economic slowdown, it is a common strategy for many SWFs to move its focus domestically to temporarily help support their financial systems and act as stabilization fund. Libya is currently in need of rebuilding. LIA has the cash reserves to play an important role in collaborating with the Libyan government in the efforts to rebuild. LIA can do this by directly investing in the economy or by forming JV’s (joint ventures) with European, American and other regional companies in Libya.
Some might ask why Africa? The answer is simple and it is the same reason why many of the world’s largest economies, including the U.S. and China, are placing a great deal of attention, efforts and money in Africa. Africa is one of the world’s fastest growing economies and will continue to be for the next 25 years. About a third of the 54 African countries have a GDP growth of more than 6% with a total GDP of $2 trillion.
Africa has 52 cities with 1 million people or more; this is comparable to Western Europe. Africa is growing, and stabilizing politically and economically. African countries will need infrastructure, education, health care, retail and more. Libya is no exception to these needs. With a current population of 1 billion people, and continued population growth, Africa expected to have a work force bigger than China by 2035. Africa also possesses the world’s largest available cropland, measuring 590 million hectares. Investing in Africa, an area Libya is familiar with will provide economic benefits to Africa, Libya and LIA.
The fund’s Capital allocation for new investments in the next 3 years can be as follow: 50% in Libya, 25% Europe, 25% in the U.S. Now I do not recommend disposing of any assets currently in Africa, currently valued in the billions of dollars. LIA should commit human resources to better manage its current commitments.
LIA needs to establish a U.S. office and gradually enter the market. This is the biggest market in the world, valued at $6 trillion, with a great selection of commercial properties to choose from. For tax purposes, I recommend less than 50% ownership in core and core plus properties through JV’s with local real estate companies, pension funds, insurance companies and investment firms.
In Europe, LIA’s office in London can be used as a base for its real estate fund. LIA’s interests in the Middle East and Africa can be managed from London. A London office provides ease of access to global markets and the availability of employees with the knowledge, skills and ability to be skilled managers and analysts.
What type of property types should LIA invest in?
Real Estate sector classifications include office, industrial, retail centers, apartment, residential, land, development and hotel. LIA currently hold retail in Yemen, offices in London and hotels and land in Africa. Using the economic factors discussed in this paper, LIA should complete a detailed research on each sector within Libya, Europe and the U.S. By establishing limits on each sector to limit exposure to risk. In brief, LIA needs an investment strategy and an energetic Chief Investment Officer (CIO) with knowledge of the markets to implement the strategy.
In Libya, the focus should be on mix-use development, Retail, Logistics, Affordable Housing, and Entertainment infrastructure. In Europe, short-term focus should be on office, and retail, both in primary and secondary markets and long term planning on hotel. In the U.S., focus on Industrial, office and logistics and long term planning on hotel sector. LIA should invest in both primary and secondary markets for a better yield diversification. In Africa, first LIA needs a complete overhaul of its hotel holdings, and a focus on Agricultural land. LIA’s problem in Africa is management.
Risk Classification
Should LIA invest in Core, Core Plus properties, or Value- added or opportunistic type of property? LIA lacks an investment policy in place to safely allocate capital to each type without exposing the fund to high risk. In Europe, and for the next 3 years LIA should focus on 80% core plus and 20% Value- added. In the U.S. market I think it should be 70% Core Plus, 20% Value-added and 10% opportunistic. In Africa, LIA should focus on how to better manage and strengthen what they currently have. The average rate of return will differ from one class to another. According to a 2005 study by Ernest & Young, core has a return of 7% – 10%, core plus is at 10% – 13%, value added 14% – 17% and opportunistic at 18% and higher.
Management and Human Capital
As a SWF LIA is lacking in human capital. LIA needs to aggressively put a program in place to better train and educate a new generation of Libyans to be able to make investment decisions and manage its current and future holdings. While LIA has, a short list of employees with the knowledge, skills and abilities (KSA) to manage portfolios, it has no employees with demonstrated proficiency in project management or direct investments. There are significant opportunities to prepare candidates for placement in the foreign market executive positions. Currently, many of LIA’s managers are placed in executive positions in foreign markets without having the basic language skills or the knowledge of the host/recipient country regulatory laws and knowledge of the host / recipient investment market.
LIA should adopt an aggressive short-term educational plan in cooperation with the ministry of education to send at least 20 recent graduate students every year for 2 years, for a Master’s Degree study in the fields of Finance, Economics, Management and Real Estate investments. Students should be sent to American and U.K Universities and this program should be restricted to only the top 10% graduates of their class with a promise of an employment opportunity with LIA and its subsidiaries after program completion. LIA needs to build up its internal expertise to be able to compete in the investment world. I think young Libyans deserve this chance to help build their future wealth. LIA London offices and if possible the U.S. can be used as short-term training centers for current staff and internships for top university students in the summer.
Investment Structure
Investment structure is the vehicle or the structure by which an investment can be held. This is important to limit liability and protect other assets belonging to the CBL (Libyan Central Bank) and the Libyan government. LIA has had a recent incident where an investor from the MENA region had filed a lawsuit and has attempted to put a hold on billions of dollars worth of CBL and government assets abroad.
Luxembourg seems to be an ideal place for investments made in Europe where corporations can be formed. The structure is going to vary from investment to another and from country to another, but focus should be on limiting liability and saving on taxs.
Summary of operational policies and proposals to consider by LIA:
- Environmental issues.
- Oversight of real estate property and control.
- Tax cost.
- Limiting administration costs.
- Protection of CBL and Libyan assets.
- Proper subsidiary / corporate structure.
- Risk management and assessment.
- Corporate governance & transparency.
- Tax benefit agreements with investment recipient countries.
- Joint Ventures with successful SWFs in Libya, Europe and the U.S.
Real estate is a constantly changing world. Forecasts and research is updated on monthly, quarterly and yearly basis. Investors’ success will depend on their ability to closely monitor economic changes locally, regionally and globally.
References
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