Money flows in Euros

Naked appetite for higher yields drives cross-border activity, writes Roxane McMeeken Europe’s property market has seen a massive upsurge in cross border fund flows since the introduction of the euro. However, while investors are paying lip service to the need for diversification, their real motivation for investing abroad appears to be a simple appetite for higher yields. European cross-border fund flows doubled over the period from 1999 to 2000, according to Kiran Patel, global head of research and strategy at Axa Real Estate Investment Managers. Flows have historically been particularly strong into France, the Netherlands and the UK, which until 2000 have together received 90 per cent of funds, he says. However, in the past two years this percentage has fallen to 66 per cent, with Belgium, Italy and Spain receiving a growing share of the pot. According to Axa figures, Spain’s real estate market took in E150m of foreign investment in 1997. This leapt to E1.7bn in 2000 and E1.45bn in 2001. So far, the country has seen E840m of overseas funds come in during 2002. Mr Patel puts the explosion of cross-border fund flows down primarily to the introduction of the euro. He says “capital has become more mobile in real estate and it’s generally easier to invest abroad”. The euro has eliminated exchange rate risks from many cross-border transactions and some investors want a better match between their liabilities – denominated in euros – and their property assets, most of which have in the past been domestic. Low interests rates are another important driver, believes Mr Patel. “In 1990, the cost of debt was 14 per cent and yields on property were 7 to 8 per cent. Now, in the UK the cost of debt is 4 per cent and in continental Europe it’s 3.25, while yields are the same. Basically, property has now become self-financing.” Guy Morrell, chief investment officer for property at Henderson Global Investors, says that “some countries are being served by better quality data, and the introduction of property indices in some continental European countries by the Investment Property Databank (IPD) is an important development”. Dr Morrell adds that “more investors appreciate the benefits that can arise to future performance – either higher returns or lower risk – from investing outside domestic markets”. Over at LaSalle Investment Management, European director Robin Goodchild argues that when it comes to diversification, property investors are merely talking the talk. Their true motivation for venturing across borders, he says, is the naked pursuit of higher yields. A study by LaSalle into investors’ motives states: “If investors were using diversification as a cross-border investment strategy, one would expect to find higher levels of deal flow between those countries where real estate markets were historically less correlated.” But this proves not to be the case: “Although investors often refer to the diversification benefits of international investing, apparently they are not pursuing this path.” The report continues: “If yield arbitrage strategies were employed, capital would flow from countries with lower-yielding markets to those that were higher yielding.” LaSalle’s research showed that deals were indeed flowing in this direction. For example, the UK attracted the highest proportion of foreign investment in its real estate market from Germany, where yields are among the lowest in Europe, for instance, 5.1 per cent in Frankfurt compared with 9.4 in Prague and 8.1 per cent in Lyon. This trend is not as worrying as it might at first seem, believes Mr Goodchild. While with other asset classes past performance provides no guide to future returns, with property, current pricing does determine future yields. Therefore to pursue diversification alone in real estate is “a bit purist”, he says. But Mr Goodchild insists that investors should not forget diversification. Hence LaSalle maintains a 10 per cent exposure to the troubled German property market in its Euro Five Fund.