Real estate and asset-backed investment manager, Long Harbour, has launched its first European fund, the European Ground Lease Fund, which it intends to grow to a €400m vehicle within the next few years.
The dedicated European Ground Lease Fund will focus on Germany, targeting commercial real estate assets in high-performing European markets.
‘We’ve spent a lot of time looking at the depth and scope of the market,’ Richard Silva, executive director at Long Harbour, and who will manage the fund, told REFIRE. ‘We’re looking on closing the first two acquisitions on behalf of the fund in Germany and in Ireland in January and February next year. They have a combined value of around €20m.’ (Further details cannot be disclosed at this time.)
The fund will invest in ground leases on residential and commercial real estate assets across Europe. Long Harbour has an initial €30m to deploy through the new fund, and a further €370m committed from investors, bringing the total available to €400m. The vehicle will target ground leases in strong European markets, including Germany and Ireland, and across all asset classes.
‘It’s an open-ended fund so it will take a few years to invest in it but after the initial three-year stabilisation period, we’d like between 60% and 80% of the fund to be invested in Germany, with an additional 20% in the Netherlands and the remainder elsewhere in Europe,’ Silva said. ‘The attraction of Germany is that it allows us to invest in a market that is both wide and deep. Our investments will be micro-location dependent, although we see good opportunities in secondary and tertiary cities. After the third year, the fund has a minimum distribution yield target of 2.5%.’
Ground lease funds new to German market
While ground lease funds are quite common in the UK, they are new to the German market, according to Ralf Kemper, head of valuation and transaction advisory in Germany at JLL: ‘It’s the same story: something starts in the UK, is quite successful, and then comes to Germany as it’s the biggest market in Europe,’ he told REFIRE.
Ground leases are essentially a bond-like asset class, not least because they are not exposed to property market fluctuations in the way that the assets upon them may be. And more investors are starting to look at them, according to his colleague, Achille Simo, senior director at JLL: ‘The returns aren’t stellar – normally between 2% and 5% - but they are safe and, importantly, you have a return without any letting risk and without building depreciation.’
However, it may be a challenge for Long Harbour and other would-be ground lease fund managers find enough plots with heritage building rights (HBRs), according to Christian Kadel, head of capital markets in Germany at Colliers International: ‘I understand that there are a few deals in the market,’ he said. ‘It might be easier to do deals like this in B and C cities, as it requires a certain yield spread between land and buildings. I think structuring ground leases makes more sense for out of town land. We’ve just re-traded a leasehold deal where a consortium sold off the land and property separately before. Typically, a ground lease will account for between 33% and 50% of the overall price.’
Long Harbour’s fund is designed to offer a unique financing structure to landlords looking to unlock value from real estate assets. By separating the ownership of land from the property that sits on it, landowners and asset managers will be able to finance their commercial buildings while investors will be able to access a reliable long-term investment in a low risk asset class.
‘We know that the ground lease model works well in the UK and US, and we believe there is significant demand emerging within Europe,’ Silva added.
Downsides to investment
Nonetheless, there can be a downside to investing in leaseholds, according to Kemper: ‘Leaseholds are indexed with CPI, which is around 2%,’ he said. ‘You have a steady income, but the downside is that if the land goes up by 4% in value and CPI is 2%, you’re only going to get half of that, so you won’t directly benefit from the increase in value – however, in the long term, investors benefit from increased land values as the site gets back to them after expiry of the ground lease.’
Given the low interest rate environment, investing in leaseholds could appeal to pension funds and insurers, according to Simo. ‘Insurances and pension funds could be really interested in ground leases because the 10-year bond rate is minus 0.8%; compared to that, 2% seems good. I think ground leases will become more mainstream over the next two-to-three years, with more investors and service providers becoming interested. The most important aspect is where the building is located, rather than its use.’
And the opportunities to acquire leaseholds is expected to grow because cities such as Hamburg and Frankfurt are increasingly holding onto sites and just leasing them as opposed to selling them, according to Kemper. ‘I think we’re all going to have to deal more with leaseholds in the future,’ he said. ‘Pension funds and insurers are the most keen to acquire sites. In a low yielding environment with a lot of liquidity, ground leases could become really big but it’s too early to say just how significant they will become.’
Some players are willing to commit serious capital to such leases. ‘There are players willing to invest a lot of money and we are aware of some triple-digit million euro deals currently in the pipeline,’ Simo said, declining to provide further details. ‘The successful closing of these deals will propel the interest of funds such as the one recently launched by Long Harbour with a clear focus on Germany.’
Other real estate investors joining the fray
Other real estate managers are also getting in on the act. Last month (November), Alpha Real Capital, which manages long income real assets, launched its Luxembourg-based European Long Income Fund (ELIF), which will target Euro denominated, asset backed, secure inflation-linked income streams by investing in commercial ground rents and amortising income strips and long lease property. The fund’s focus will be ground rents and income strips at the lower end of the risk spectrum in the Eurozone, with an initial focus on Germany, the Netherlands and Ireland.
‘With nominal yields in northern Europe forecast to be close to zero or negative for the long term, we believe that secure income derived from long income property is an increasingly attractive asset class for European pension funds and insurers,’ said Hugo James, partner and head of long income at Alpha Real Capital. ‘The fund’s strategy is focused on commercial ground rents and amortising leases. We believe these structures can offer new and attractive funding solutions to owners and acquirers of operational real estate,’ he added.
