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Subprime shock could “stifle” European real estate investment

A leading fund manager said today that the shock waves emanating from the subprime mortgage crisis in the US could stifle investment activity in the European commercial real estate market.

Ric Lewis, chief executive of London-based boutique fund manager Curzon Global Partners, said today that real estate investment activity across Europe could slow for the rest of the year. Lewis, who doubles as chief investment officer at pan-European fund manager AEW Europe, added that tightening credit lines at banks could also lead to casualties among highly leveraged investors.

“The US commercial real estate market is shutting down and it is unlikely that Europe will be immune from the impact of the crisis as one very rarely gets this level of volatility without distress and dislocation,” Lewis said in a statement issued by Curzon. “We hope that there is just a brief liquidity squeeze that takes the froth off the market, but this should be a wake-up call to investors.”

Lewis said a “wall of money” has flowed into European real estate investment over the past three years making yields plummet. But with commercial mortgage-backed securities spreads spiking and banks’ ability to securitize loans now drying up, the danger is that they will cut off the cheap debt pipeline, forcing borrowers to abruptly curtail their investment programs, according to the firm.

Simon Martin, managing director and head of research and strategy at Curzon, added that it’s “inevitable” that European property yields will have to increase because, in many markets, they are currently below the cost of borrowing. In addition, he said people’s appetites for paying low yields will ebb and market players will start to re-base what real estate assets are worth. 

“It could be like watching a slow car crash,” Martin said in the release. “Leveraged marginal players who no longer have capital to deploy might find themselves under pressure from shareholders and may have to wind-up as their share prices fall. If liquidity dries up and bid/ask spreads open, the market could get very quiet. I think we could be in a situation such as the late 1980s and 1990s where everybody is waiting for the end of year valuations to come in and activity simply dries up in the final quarter.”

Martin adds that European real estate equity markets have already started to re-price and that property stocks indices are down between 15 percent and 20 percent in the year-to-date, but now the process of revaluation could be shifting over into unlisted property.

The warning comes at a time when some of the larger fund managers are preparing to hit the fundraising trail. PrivateEquityRealEstate.com has learned that managers of at least two UK-focused funds have shelved plans to begin fundraising until a clearer picture emerges of market sentiment.

One City source familiar with current fundraising plans remarked that some pension funds are beginning to look upon bonds as offering “decent value” and are considering re-weighting their exposure to property.

Some say the UK is the hardest hit market, with values falling particularly for retail and industrial property in secondary locations.

“Our sense is that after a decade of strong absolute returns, property is in for a somewhat rougher ride that will need to be navigated very carefully,” Lewis said. “I am not sure everyone is prepared for that eventuality.”