INTELLECTUAL PROPERTY: Storm clouds gather

Despite a pretty good first half of the year in terms of transaction and fundraising activity, global real estate markets face stiff headwinds this fall due to uncertainty in Europe. PERE Magazine, September 2011 issue

Reminiscing about summer usually involves thoughts of travel, time off and good times spent with family and friends. For those involved in any aspect of the greater business world, however, the summer of 2011 is likely to bring only thoughts of stomach-churning fluctuations in the stock markets, a downgrade of America’s credit rating following a contentious debate on raising the US debt ceiling and a sovereign debt crisis in Europe that is spreading from periphery countries to larger ones.

Of course, the global macroeconomic picture didn’t seem quite so gloomy at the start of the summer. For private equity real estate in particular, the season began with sustained momentum in terms of both transaction and fundraising activity. Indeed, acquisition activity maintained the pace set during the spring as GPs continued to launch new funds on the back of LP commitments that had begun to trickle in.

By the end of July, however, that activity had taken a backseat to the political theatre playing out in Washington, DC. As Republicans and Democrats stretched negotiations on the debt ceiling increase to the 11th hour, uncertainty began to creep into the market, initially impacting real estate finance. Indeed, spreads on one CMBS deal widened significantly two weeks before the deadline and another deal was pulled altogether in the final week.

In the end, a compromise was reached, as most believed it would, in order to avoid an unprecedented default by the US. Unfortunately, the compromise came up short in the most important aspect of the negotiations – avoiding a downgrade of America’s top-tier debt rating.

Standard & Poor’s had said all along that it would lower the US’ sovereign debt rating from triple-A to double-A if Congress did not achieve a longer-term hike in the debt ceiling and roughly $4 trillion in savings through a combination of significant cuts and lapsed tax breaks and subsidies. So when the legislature approved a deal with only half the savings, the ratings agency followed through on its promise. The point of the entire exercise obviously was lost on the politicians, as they went back to blaming each other for the outcome.

Despite the severity of the US situation, it is but a hiccup compared to the looming threat across the Atlantic. The European sovereign debt crisis, if not properly addressed, threatens to pull the world back into recession, and could even shatter the eurozone and its common currency. Much like the US, the politicians there also seem to be losing sight of the bigger picture.

Since the fall of 2009, a series of negotiations, bailouts and austerity packages have failed to stop the slide in investor confidence or restore the growth needed to give struggling countries like Greece and Portugal a way out of their debt spirals. Last month, European leaders found themselves scrambling once again to intervene in the markets, this time to protect Italy and Spain – two countries seen as too big to bail out.

While the European Central Bank put another bandage on the situation with its bond-buying program, Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France sought to craft a deal of their own, calling for each eurozone nation to insert a new rule into their constitutions to work toward balanced budgets and debt reduction. At the same time, they ruled out issuing Eurobonds as a means of sharing responsibility for government debt across member states and opposed a further increase in the bailout fund, which won’t even be in place until later this month. Many see Eurobonds as the best short-term solution to the crisis, so it is particularly disappointing that the option has been ruled out by the Union’s two biggest member states. 

Luckily, the US downgrade does not seem to have had a significant lasting effect on the markets. Stock markets have begun to rebound from their declines, and real estate transactions and fundraising continue stateside. Indeed, a number of LPs have committed to new real estate funds over the summer, although some of those decisions were made before the gloomy days of August. Time will tell if equity commitments keep rolling in or if LPs decide to tap on the brakes.

For private equity real estate firms operating in Europe, however, event risk now becomes a real consideration, and not just in those markets facing difficulty. While some think this only will widen the gap between investments in periphery countries like Greece, Spain and Ireland and those in core countries such as the UK, France and Germany, others worry that the eurozone will fracture and the common currency will dissolve, causing untold problems for existing euro-denominated funds and sending the Continent back to the days of currency- and market-specific vehicles.

I don’t think we are at the latter extreme just yet, but it isn’t hard to imagine getting there if European leaders continue with their bandage approach and consider their interests ahead of the greater good. In the meantime, expect most LPs investing in European real estate to stick to core strategies in the larger markets, at least until there is some sort of clarity and plan of attack for the crisis.

While the market is resilient and can handle most situations (or find other ways to get deals done), what it doesn’t like is uncertainty. So, in regards to the European sovereign debt crisis, learn something from America’s dysfunction and just do something already.