Several European countries are battening down this week for a second wave of public lockdowns to stem the spread of covid-19, and speculation is turning to the potential economic aftermath of these mass closures. But a look at one leading European indicator—commercial sale-leaseback activity, or the sale of real estate assets to investors, who then rent assets back to tenants—is showing relative resilience in the time of covid, not just in terms of deal opportunities, but also in rent collection levels.
According to Christopher Mertlitz, Executive Director of European Investments for publicly-listed net-lease REIT pioneer W.P. Carey, the company—which pioneered the sale-leaseback model 50 years ago in the U.S., and has helped to grow and professionalize the European market in the decades since—Europe’s investment appetite for positive-yielding assets has been robust ever since the onset of the Great Financial Crisis in 2008. And this demand has only strengthened in the time of covid, a crisis without modern precedent.
“What we’ve seen since covid really hit the world in Q1 of this year…on the one side, [since the Great Financial Crisis], we’ve seen an ongoing reduction in yield, unprecedented central bank policy and monetary policies, [bond] yields compressing, compressing, compressing,” he said. “There’s a lot of hunger and appetite for income, whether it’s pension funds, insurance companies, or other large institutional investors, or private individuals. So, the desire for long-term, predictable income, while it’s always been there, I think, given the low-yielding environment that we’re in, has just become even more acute.”
W. P. Carey has been at the forefront of this trend, ranking among the world’s largest net lease REITs, with an enterprise value of approximately $18 billion and a diversified portfolio of operationally-critical commercial real estate in the U.S., Northern and Western Europe that includes 1,215 net lease properties covering approximately 142 million square feet as of September 30, 2020.
Its portfolio has long been highly diversified, spanning high-quality single-tenant industrial, warehouse, office, retail and self-storage properties. All of these targets are typically subject to long-term net leases with built-in rent escalators, making them attractive long-term income-generating investments.
A strong fall
Mertlitz says W.P. Carey successfully collected 99 percent of rents from its European tenants in the month of September, following a similarly strong performance in August. He attributes this performance to a couple of key factors.
One has been the firm’s slightly different angle on investing in the bottom-up, long-haul “mission-criticality” of an asset, rather than overweighting or underweighting specific geographies or sectors.
Second has been the inherent portability of the sale-leaseback model itself, which Mertlitz says can be deployed in the “north of Norway or the south of Spain,” mostly irrespective of country geography. The most important factor for Mertlitz and his team is identifying “mission-critical” assets, no matter where they are.
The sale-leaseback structure, he explains, is one financing “tool” in the toolbox of a business owner, and one that has been better suited to some sectors than others during the trials of covid. Brick-and-mortar retailers not offering essential products (like grocery stores) have, not surprisingly, been adversely affected by covid. But many of these companies were already at the mercy of structural changes to consumer behavior as a result of the digital shift that has fed demand for logistics and digital properties.
Mertlitz adds that during the initial onslaught of covid in the spring of 2020, and Europe’s first experience of lockdown and heightened uncertainty, companies did look much more closely at selling owned real estate as a way of raising much-needed capital, and retailers were no exception in this regard.
What remains to be seen
As to how covid may fundamentally or permanently change Europe’s commercial property market, he says much is yet to be revealed—particularly the office landscape. Mertlitz says that office markets in Europe’s second-tier gateway cities, whose workers are likelier to commute to work by car than in capital cities, where workers depend on crowded public transportation, have been relatively more resilient. Will this be a staying trend?
“There’s a lot of structural change happening across all kinds of asset classes,” he explains. “We’ve experienced now—let’s take office [real estate], for instance—a time period of months on end where a large proportion of the office-bound population has been working remotely. We’ve never had that [before]—it’s one big social experiment. And no one really knows what long-term impact that will have on the use of office. I don’t think anyone expects that offices are going to disappear altogether—that would be unrealistic. But, on the flip side, it would be unrealistic to expect that this completely global, unprecedented experiment is not going to have an impact on the office environment.”
Ultimately, the firm’s capacity to invest for the long-term, not reliant on the outcome of near-term crisis scenarios (including, not just covid, but also Brexit) and its ability to access public capital markets as a listed firm, stand it in good stead to capitalize on opportunities as they unfold in these unusual times.
”We’re keeping our eyes open, and we’re prepared to deal with whatever the market throws at us,” Mertlitz says.
…Speaking of which
This week, W.P. Carey announced a $102 million (€87 million) sale-leaseback of a 27-property supermarket portfolio located in Northern Spain and the Balearic Islands. The deal brings the company’s total investment volume for the year-to-date period to approximately $700 million.
The portfolio comprises a total of 481,000 square feet, and is triple-net leased under three 20-year master leases, with Spanish CPI-based rent escalations, to Eroski Sociedad Cooperativa. Eroski is one of the largest food retailers in Spain, whose food retail market has demonstrated consistent growth and rising shopper spending on consumer staples, with demand remaining largely unaffected by covid-19.