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Investment strategies for European equity sources.

While 1992 will show a general decline in overall vacancy rates and a noticeable improvement of the volume of investment activities, it will still be considerably different from the anticipated expectations of the industry.

High expectations have fueled high disappointment, which has caused European investor groups - especially Germans - to reexamine their investment strategies.

In 1990, when the domestic real estate market went into paralysis, European investor groups had begun their analysis. In 1991, when domestic investors were in a denial phase, European investors recorded a few cautious transactions. Although that in 1992 a general acceptance for more transactions was prevailing, the anticipated benchmark for European investments could not be reached. Particularly Germans, that our firm is dealing with, had already established their "game plan" in 1991, by focusing not only on bottom-up but also on top-down portfolio analysis. This new strategy still did not achieve their acquisition goals. Their intents were to invest more money then they actually did. Even though they were familiar with a tightened financial and regulatory environment, because of their experience with the one in the early 80's caused by the German "S&L Disaster' (involving the "Reiffeisen Bank"), our European investor groups were not able to take full advantage of prices that might never again be so severely discounted.

The main reason for this "partial' investment success is the disparity between seller motivation and buyer valuation methods. In a market where the word "appreciation" has become exotic and where residual value is nominal, buyers have adopted a more conservative basis of valuation, resulting in values far below the seller's expectations. This is particularly true since European investors apply very conservative discount rates and capitalization rates to current cash flow. Their allocation to real estate is a specifically yield driven decision. With actual yields of 9 percent p.a. for a riskless short-term deposit in any German bank, it is quite understandable that new acquisitions - regardless of the geographical area - with less than 11 percent (on residential) or 15 percent (on commercial) cash on cash returns, are not even considered. In addition these investments must have at least a 70 percent (residential) or 85 percent (commercial) occupancy.

Another reason why the European Investors have been more cautious than anticipated is because of the general climate of the market that makes one deal with 'distressed property portfolios.' With many institutions and the RTC unloading real estate in mass quantity, these deals require an intense screening and a very costly due diligence process. Together with the countries leading portfolio analysis firm, Rye, New York-based Real Estate Evaluation Services, Inc., our firm has looked at a number of portfolios in the past 12 months. As most buyers observed, we found these institutions to have an unrealistic, or regulatory-constrained, view of real estate values. Also most of these portfolios contained some properties that are never again going to be viable. Sometimes these properties were so bad that their negative value would have impacted the rest of the portfolio.

In addition to the above mentioned structuring requirements, all intended acquisition require highly complicated financial engineering proceedings. This is due in part to the financial environment in Europe, and because sales prices are continuously dictated by balance sheet concerns and government regulators. Furthermore this environment is continuously impacting the determination of values. Appraisers already are having a hard time to establish evaluations through the comparative sales approach. They don't know whether the sales price was the result of a forced sale or was actually fair market value.
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Title Annotation:Review & Forecast, Section V; past disappointments cause European real estate investors to reevaluate investment approach to U.S. real estate market
Author:Rosenberg, Wilhelm A.
Publication:Real Estate Weekly
Date:Jan 27, 1993
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