CONVERSATION(S) : Christopher Mertlitz, Managing Director-Head of European Investments, W. P. Carey

Summary

Christopher Merlitz, Head of European Investments at WP Carr, discusses the evolving landscape of the European commercial real estate market amid rising interest rates. He highlights the challenges faced by investors due to uncertainties in valuation and financing. Despite these hurdles, Merlitz is optimistic about increased transaction activity as the market stabilizes. He emphasizes WP Carr’s resilient sale-leaseback strategy, which has been effective for over five decades, and anticipates more opportunities, especially from private equity firms seeking to de-leverage. Merlitz sees the current macroeconomic environment as a chance for growth in their niche market.

Takeaways

• 😀 The European commercial real estate market is currently in a transition phase, following nearly two years of rate hikes, which has created instability for investors.
• 😀 Analysts are anticipating potential rate cuts in the near future, possibly in April or later in the year, depending on the economic outlook.
• 😀 Despite the challenges, there is optimism in the real estate sector, with expectations of increased transaction volume as the macroeconomic environment stabilizes.
• 😀 The biggest challenge facing real estate investors today is uncertainty around valuations, particularly in the context of limited transaction evidence.
• 😀 Real estate funds, especially those that benchmark valuations relative to net asset value (NAV), are struggling due to discrepancies in valuation caused by the lack of comparable transactions.
• 😀 Investors who are more leveraged or dependent on debt financing are finding it difficult to secure favorable borrowing terms in the current environment.
• 😀 WP Carried’s strategy, focused on single tenant sale-leaseback transactions, is positioned to take advantage of this new phase of higher interest rates, with a positive outlook for increased deal volume.
• 😀 The firm’s approach has remained consistent for over five decades, focusing on providing long-term, inflation-protected income through secure, solvent companies.
• 😀 The sale-leaseback strategy is seen as somewhat anti-cyclical, with more companies likely to consider it as a means of raising capital, particularly in softer macroeconomic conditions.
• 😀 Private equity firms are becoming increasingly active as sellers, driven by pressure to reduce debt and de-leverage their portfolio companies, which presents additional opportunities for WP Carried’s strategy.
• 😀 Overall, despite challenges, the sale-leaseback model remains resilient, with significant potential for continued success in both stable and uncertain market conditions.

Q & A

What is the current state of the European commercial real estate market according to Christopher Merlet?

Christopher Merlet mentions that the European commercial real estate market is stabilizing after nearly two years of high interest rates. This stabilization is expected to bring back transaction volumes, driven by pent-up demand and increased certainty in the macroeconomic environment.

How have the interest rate hikes affected real estate transactions in Europe?

The high interest rate hikes over the past 18 months have made it difficult for real estate investors to price transactions accurately due to the resulting uncertainty. This has led to a significant reduction in transaction volumes across the market.

What challenges are investors facing in the current market?

Investors are facing challenges such as difficulties in pricing transactions due to a lack of comparables, as well as the high cost of borrowing. Traditional funds that rely on valuations and NAV (Net Asset Value) are struggling, while leveraged buyers face issues obtaining favorable debt financing terms.

What is WP's strategy in the current market environment?

WP's strategy remains focused on providing long-term, inflation-protected, secure income through sale-leaseback transactions. This strategy has been successful for over five decades and continues to be relevant in the current market despite macroeconomic challenges.

How does WP's approach differ from other real estate investors?

Unlike many investors who rely on debt financing, WP operates as an all-equity investor, which allows them to avoid the challenges posed by high borrowing costs. Their focus is on spread-based transactions, which prioritize securing income relative to their cost of capital.

What role does the sale-leaseback strategy play in WP’s operations?

Sale-leasebacks are central to WP's operations, offering companies a way to raise capital while securing long-term leases. This strategy is particularly beneficial in uncertain times when companies need to reduce debt or fund business investments.

What impact has the macroeconomic environment had on transaction momentum?

The macroeconomic environment has created a situation where there is more pressure on companies to reduce debt, especially among private equity firms. This has led to increased transaction momentum, with more companies turning to sale-leasebacks as a means to manage leverage.

What is WP’s outlook on the future of the real estate market?

WP is optimistic about the future of the real estate market. Despite challenges, they believe that the current environment will lead to more transaction activity, especially in niche areas like single-tenant sale-leasebacks. They see the market entering a phase that will foster more deal flow.

How do private equity firms factor into the current sale-leaseback market?

Private equity firms are particularly active in the sale-leaseback market, as many of their portfolio companies are highly leveraged. Sale-leasebacks offer these firms a way to reduce debt and restructure their portfolios, making them a key group of sellers in the current market.

What is the primary focus of WP when underwriting potential deals?

WP's underwriting focus is on identifying good, solvent companies with strong credit. They prioritize stable, long-term partnerships and secure income, which has been a consistent aspect of their strategy for over 50 years.