Portfolio Transactions - challanges and opportunities in complex real estate deals

Author Michael Hermes, shareholder and managing director of ATOS Asset Management and ATOS Property Management

Hardly any other form of real estate transaction polarises experts and market participants as much as portfolio deals. The opinions of institutional buyers range from fear of the perceived risks of a mixed bag, with which large property companies have already failed, right through to the conviction that one can still achieve attractive returns through such transactions - especially in a hot market.

In considering these transactions, portfolio buyers currently face the same question as all other players on the real estate market: Where are we in the current cycle, are there signs of overheating of the market? There is no question that the development of purchase prices and the decline in yields are clear indicators of such a trend. But there is a significant difference to the situation 10 years ago, when the boom finally ended quite unceremoniously: The high demand from international capital is supported by broad demand from German institutional investors. The speculative element, the hope of further declining yields, currently plays no comparable role - rather, the low interest rate environment attracts investors to the real estate market. Many investors are primarily interested in deals with sustainable yields, as long as preservation of capital is guaranteed. Only when interest rates are consistently at higher levels can a cooling off be expected, due to the resulting reallocation of investor funds to other asset classes.

But there is one point on which all experts agree: Especially for portfolio transactions, the key to investment success lies in professional asset management.

Portfolio deals are back

In practice, portfolio deals have once again become increasingly important in Germany in recent years. Although this form of real estate transaction almost completely disappeared after 2007, due to the financial market and real estate crisis, it has recovered step by step. Pan-European deals with German components led the way, usually in the form of very homogeneous packages, i.e. a single asset class like hotels, with an identical anchor tenant in all properties.

Mixed, heterogeneous portfolios, however, for example in the areas of office or commercial real estate, were almost impossible to sell in Germany for several years. Therefore, sellers such as open real estate funds in dissolution, or financial investors under sales pressure, saw themselves faced with the challenge of marketing their properties individually. Naturally, the good properties sold faster, and there remained an inventory of real estate with significant weaknesses in terms of location, site or property quality.

It is only in the last 18 months that the situation has changed for portfolio transactions. While many sales processes have failed in the past few years due to different price expectations, an increasing number of successful transactions can now be observed. Obviously, the continuing high demand from domestic and foreign institutional investors for German real estate, and the resulting pressure on the property yields, means that alternative strategies will be sought. This can take the form of many different approaches, such as investing in B and C locations, an increased willingness to take risks with a view to adding value, or opportunistic investments or related assets such as real estate financing or portfolio deals.

 The portfolio deals of the past months cover the full spectrum, from core to value add, right through to opportunistic. A distinguishing feature is that the properties in the portfolios generally are in the same risk class. The buyers therefore expect a certain degree of homogeneity in terms of the individual properties.

The sales are mostly organised as a multi-stage bidding process. However, due to the complexity of portfolio deals, potential buyers are often granted exclusivity earlier than in the case of individual properties. Then the due diligence costs for portfolios pose a risk factor for the buyer.

Challenge for asset managers

The buyer should already select an asset manager during the course of the due diligence and the development of the business case, in order to best profit from their know-how, and to ensure a common commitment to the business case. A further advantage of this early involvement is the preparation of a rapid handover of the portfolio, and the speedy implementation of the required measures.

Fundamentally, the service provider must be able to successfully manage a diversified portfolio, with regard to the structure of the portfolio, regional distribution or type of use. Especially in the case of non-core transactions, this represents a major challenge.

In the course of the acquisition of the portfolio, transferring the property data into its own database, and if necessary collecting any missing information, i.e. the improving data quality, is the first important investment. It is also important to incorporate the results of the due diligence, and in further proceedings to clean up risks from the purchase contract, if possible, or at least to keep an eye on them.

The focus from the first day onwards is on quick wins. The faster the asset manager gets to work, the more successful the transaction can become. Naturally, the duties of the asset manager also include helping optimise the strategic course of the owner. The work on the properties in the portfolio is influenced by the question of the future of the inventory: should the portfolio be retained, should it be sold as a whole or the properties sold individually, or do the owners even plan to restructure the portfolio by acquiring further properties? Is the goal sustainable yields, or a short-term increase in value and resale? All this has an influence on the objectives and the approach of the asset management. Accordingly, it is decided where and to what extent the asset manager’s tool kit is utilised, from facelifts to refurbishments right through to repositioning of individual properties.

From the outside, it is not always easy to assess whether or not a portfolio transfer was successful. For example, if a portfolio changes hands relatively quickly for a second time, this can also simply be due to a fast exit on the basis of an attractive, increased portfolio price. Irrespective of this, experience has taught us that as a rule, the success of a transaction is achieved with the last third of the properties. The quick wins ensure a solid start, but the real success comes with the last properties, with which the asset management can prove themselves. Here, the quality of the asset management determines the economic success or failure of a portfolio deal. Specialists are required - in particular for difficult real estate - who have the experience and know-how to fulfil the value enhancement potential, even under such conditions.