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Informed bargain hunting – investing in distressed property

In September 2008, Spanish private bank Banco Urquijo opened its brand-new headquarters to much fanfare on one of Madrid's most exclusive streets. The building on Calle Serrano was unveiled to a 500-strong audience that included some of the biggest names in the Spanish business world.

Urquijo's goal was clear. As one of the most traditional banks in Spain, specialising in the provision of tailor-made services to wealthy clients, it wanted to show that the financial crisis had not brought it to its knees.

Six months later, however, the building was sold to multifamily office Grupo Metropolis because Urquijo's owners, Banco Sabadell, were forced to look for alternative ways to raise money as the interbank lending market stalled. They agreed a sale and leaseback contract, something José María Xercavins, CEO of Grupo Metrópolis, is a big fan of in the current environment.

"We love sale and leaseback," he says. "We have over half a dozen buildings in that situation in our portfolio."

Nick Cartwright, the director of corporate tax at investment advisers Smith & Williamson in London, agrees that distressed property investing is back in vogue. "It is a good time to get back to property investments if you have cash and you can find a tenant with a very good covenant, such as government bodies, education establishments supported by a government or blue-chip companies," he says. "The key right now is the quality of tenants."

In the current environment companies have discovered that paying attractive rental rates to investors such as Grupo Metropolis can enable them to raise money in a more cost-effective manner. It has been reported that Banco Sabadell is paying Grupo Metropolis a lease that amounts to a 6.5% rate of annual return on the estimated €35.7 million paid for the building.

In order to take advantage of these kinds of opportunities, Grupo Metropolis launched Metroinvest, a €500 million fund intended for property investment, in January 2009. Six family offices have shares in Metroinvest, alongside clients of the private banking unit of La Caixa, a large Barcelona-based bank.

"The idea to join forces emerged from the realisation that, individually, no family office has the capacity to make a purchase nor the strength to negotiate that several family offices working together possess," Xercavins says.

Although the decision may have looked odd to some people, especially as property prices in Spain and other European markets remained in free fall, Xercavins has a different take on the situation. "Today you can buy assets in Madrid, Paris and London at prices that are 40% or 50% lower than a couple of years ago," he remarks. "It's as simple and as clear as that."

The Banco Urquijo deal was the first completed by the new fund, but Grupo Metropolis has organised real estate investments for family offices for a long time. It went through several ups and downs in the market but, according to Xercavins, the families that have invested with Metrópolis have had no reasons to complain. "Our audited return rate is 22% a year since we started," he says. "But it is true that we've taken advantage of a decade when prices went up in a very significant way in Spain. Moreover, we were very lucky to sell part of our portfolio right before the market crashed in 2007."

After almost two years of sliding real estate prices around the world, it might seen obvious that good deals were available for family offices with cash on their hands. But investors with experience in the sector warn that even though prices can look attractive, there is more to investing in the real estate market than finding a bargain.

Richard Weber, the managing director of Hamburg-based advisors Weber Grundstücksverwaltung AG, says that, first of all, it is necessary to have the right mind set and adapt expectations to the characteristics of the market. "You have to think like a real estate investor, not like someone who plays the capital markets," he says.

For example, one common mistake of new investors in real estate is to expect short-term returns in the same way that people can achieve with stocks. "There are lots of investors buying a property in order to sell it in two years time," Weber notes. "This strategy is not working."

Frederick M Shepperd, the head of Shepperd Investors AG, points out that during the latest property boom, many investors in the real estate market in places such as the US lost sight of the ball and tried to take advantage of rising prices at any cost.

"A lot of real estate funds and trusts were in the business of raising money to buy assets rather than looking into their investments," he says. "Now these companies are in trouble and are trying to sell healthy properties in order to deleverage."

Another factor that should be considered is that, although property markets have gone down in many places, there are some markets where they don't seem to have hit bottom. Germany is one of them, in Weber's view. Shepperd says that prices in Europe as a whole still have some way to go down, although he to is seeing opportunities in sale and leaseback in the continent.

In America, however, the situation appears more promising for real estate investors as it is set to emerge from the economic downturn before European countries. In particular, opportunities in multi-tenant commercial buildings can prove an attractive proposition. They have the extra advantage of reducing the risk of a lot of empty offices in the portfolio. "If you buy a building occupied by a single tenant, the risk of vacancy of the facility is higher than in a multi-tenant property in a core area such as Manhattan," Shepperd remarks.

The beauty of the current crisis, from the point of view of real estate investors, is that some areas that have been out of the reach of cautious investors due to stratospheric prices now can offer more reasonable deals. "We are very active in New York City and Washington, and have been able to close deals for properties which prices had shrunk by 30-40%," Shepperd points out.

Some sectors, however, require a wait-and-see posture even in America, he says. One example is the acquisition of retail properties. As unemployment goes up and consumption recedes, it is still not clear how many retailers will go bankrupt.

Weber recommends that real estate investments should be carefully examined, even when prices look extremely attractive. "There are no bargains without risks," he says. "In a market like today's, even in a sale and leaseback operation you cannot be sure that the tenant will survive the crisis."

For that reason, he suggests that investors keep focus on that old truism of the real estate market: nothing beats a good location. "You have to be sure that, if your tenant goes belly up, you will be able to find a new one in the future," Weber stresses.

Xercavins says that he and his partners always take a cautious approach to the market, focusing on some kinds of operations and avoiding others, even when they are booming. "We invest only in properties that we can rent out," he says. "We don't touch residential property development in any circumstance."

Instead, Grupo Metrópolis focuses on offices and logistics centres, but has also purchased some luxury residential properties in Barcelona and Berlin. Another sector that the group likes is hotels - its portfolio includes familiar names such as The Caesar, in London's Knightsbridge, and The Lafayette, which is located near the Place de la Madeleine, in Paris.

Despite the climate there are investment opportunities in property. However, as with every investment, due diligence is crucial to ensuring success. Family offices are accustomed to planning for the longer term, which will position them well for distressed property investment.

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