António Pereira Dias: “Investors are revising not only their own investment strategies but also their required return targets”

The CFO of Bondstone explains how Portugal's real estate market differs from its generalist private equity market.

Posté le Tuesday, January 25th 2022
António Pereira Dias: “Investors are revising not only their own investment strategies but also their required return targets”

LL: How has the Portuguese real estate market changed in the last decade in terms of the type of investors you’re seeing and the asset classes they’re focusing on?

Pereira Dias: The Portuguese real estate market has witnessed a major shift over the last decade. Before the Global Financial Crisis, the local real estate investment market was mostly dominated by small operators, commonly tied to small construction companies, mostly funded by local capital and high levels of debt. As the crisis hit, most operators were either forced out of the market or all but halted their real estate investment operations. By 2013, the Portuguese real estate investment market was practically dormant.

By 2014, a number of different factors aligned and eventually turned Portugal into a favorite destination for real estate investment: low interest rates, the progressive recovery of the banking ecosystem, new tax and legal frameworks that favored investing in selected real estate asset classes and the success of a number of local programs designed to capture foreign capital from high-net-worth individuals.

This time around, different types of players started eyeing the market. It started with new, more financially savvy local developers and dedicated investment management firms investing in new projects in the city centers, usually by acquiring derelict buildings and rehabilitating them into luxury apartments (taking advantage of both tax breaks for that asset class and high-end international clientele with greater willingness to pay). In time, larger international investors (multinational developers, pan-European investors and institutionals) started eyeing large investment projects, either partnering up with local players or, in some cases, by setting up their own local teams. This led to an increase in appetite for a broader range of asset classes, from larger residential projects to offices, retail, mixed-use projects and of course, hospitality. By early 2020, investment volumes had grown by over 90% from 2011 levels. Foreign capital is now the major driver behind real estate, representing over 85% of total investment.

The Portuguese real estate market is now a resilient and increasingly mature market, prices have continued to grow and yields continue to compress across a wide variety of asset classes.

Even in this new environment, the appetite of international investors has focused on specific real estate investments. We have witnessed tremendous appetite for logistics, but also continued interest in residential real estate, not only larger multi-family projects but also in the broader living sector (including purpose built rental projects, co-living and student housing).

The Portuguese real estate market is now a resilient and increasingly mature market, prices have continued to grow and yields continue to compress across a wide variety of asset classes.

The Portuguese private equity market isn’t known for being particularly liquid. To what extent is real estate different?

The generalist private equity market in Portugal is modest when compared to larger European economies. The local economy is mostly comprised of family-owned SMEs, most of which are too small to attract interest from even mid-cap private equity funds. On top of this (although the trend is now changing) there is still a bias from traditional owners against giving up control of the companies (even managerial control) which tends to further hinder equity investment from financial investors. These factors, coupled with access to cheaper sources of capital (namely commercial bank debt) necessarily impact the liquidity of the market.

On the other hand, the Portuguese real estate private equity market is somewhat less affected by most of these factors. Real estate investment deals almost by definition involve an underlying real asset changing hands, which means that change of control is a given. Concurrently, the massive decrease in real estate investment in the years leading to 2014/15 has led not only to a healthy supply of new projects still on the market, but also to significant growth in demand for modern properties regardless of asset class (residential, retail, offices, mix-used, etc.) assuring not only attractive exit prices but also increased liquidity at exit. Finally, as the banking sector continues to require cash equity commitments before financing an investment project, the market dynamics almost always require the involvement of a capital partner. All of this contributes to a larger, healthier and more liquid real estate investment market capable of consistently attracting international capital while generating solid returns.

 

How have low interest rates and costs of capital affected your market?

Low interest rates, decreasing opportunity costs and the fact that most real estate asset classes are widely regarded as value reserves in times of economic uncertainty have led to a massive inflow of capital into projects ranging from core investments all the way up to riskier opportunistic deals with higher target returns. This inflow increased the amount of dry powder in the market while also increasing the number of active investors. More “competition” together with the growing need to deploy capital to fulfill investors’ commitments has impacted the global real estate market. Acquisition values, decreased leverage and increased investment tickets have put pressure on returns across most asset classes. Naturally, we’re seeing an increasing number of investors revising not only their own investment strategies but also their required return targets to accommodate this trend.

Despite all this, our focus has always been on the rigorous analysis of directly originated on- and off-market opportunities capable of generating above-average returns. By maintaining a strong focus on the time-value of money and risk mitigation for such projects, our strategy has allowed us to consistently deliver a strong portfolio capable of generating attractive IRRs while maintaining a solid risk/return ratio.

 

How has e-commerce demand affected the market for logistics assts in Portugal in the last several years?

Up until early 2020, e-commerce penetration in Portugal was lagging the EU average. Despite being heavy adopters of high-speed internet, our shopping habits still had a very relational, in-person dimension to them. This changed as the country entered successive lockdowns during the onset of the Covid-19 epidemic. Suddenly, most retailers were forced to prepare for the surge in e-commerce demand, requiring a reshuffle and expansion of their logistics capabilities, particularly in regard to last mile solutions. Similarly, most specialized global retailers started eyeing the Portuguese market, looking for last mile solutions to complement their hubs in western Europe.

From the supply side, the larger metropolitan areas were not ready to accommodate this shift. Lisbon’s stock of mid- and large-scale logistics and light industrial assets totals close to 4.9 million square meters (a surprisingly low number), most of which comprised out-of-date facilities. Naturally, vacancy rates are extremely low and there is a significant shortage of new state-of-the-art warehouses, causing prime yields to compress rapidly and demand for new investment projects to surge.

We ourselves have been closely monitoring the logistics market and have partnered with large institutional investors to tackle this asset class in particular. As a result, we have built a solid pipeline which we expect to deploy in the very short term.