The impact of sovereign wealth funds

The impact the emergence of sovereign-wealth funds
is exercising on current international
residential and commercial property investment

Ask any Western property developer what he or she thinks of state intervention and the answer will probably be “not much.”

Known for their independence of thought, enthusiasm and robust approach to business and the task of constructing new premises for residential and commercial clients, developers are generally cut from sturdy cloth, ready to ride the storm clouds in search of their not inconsiderable financial targets.

These entrepreneurs, from day one, expect to carve their own way, free of state interference.

Eager to make the most in the UK of the financial resources that flowed in abundance in the UK during Mrs Thatcher’s privatisations and financial de-restrictions of the mid-198os, many of the current wave of developers - both in the UK, and in Europe - came to the fore in generally benign macro-economic circumstances.

How ironic, then, that in 2008’s severe global downturn, they find that it is government money - sourced in the US, Europe, Russia, the Middle and Far East - that currently provides a lifeline while investment values fall and the threat of unemployment empties the offices, shops, industrial units and residential homes in which they have invested and derive their income.

As a sophisticated, dynamic and yet relatively safe investment, far from the clutches of the state, property was never meant to be like this. As an asset class, its reputation used to be formidable, the inspiration of tycoons and their contracted dealmakers.

In Europe and the US, financial commentators and analysts focusing on the property sector’s prospects have come full-circle: they are unimpressed by the outlook for 2009; some, even, are calling for a re-working of 1944’s Bretton Wood Agreement (between President Roosvelt, Churchill and their allies, the Soviet states), whereby the International Monetary Fund (IMF) was created, state money is used to prime entrepreneurs and those business capable of stimulating employment and the macro-economies of trade throughout the developed world, and currencies stay as stable as possible – often linked to the value of gold.

A term that would have been unfamiliar to the two world leaders in 1944 would have been sovereign wealth fund, or SWF.

There was no indication in the mid-1940s that the exploitation of oil, in any country, would start to play such an important role within 10 years of Bretton Wood’s signing; but that is what occurred, with SWFs slowly emerging in the mid-1950s, firstly in Kuwait following the Anglo-Kuwait creation of the Kuwait Investment Board, reaching a crescendo of significance in the mid-2000s. Singapore followed with its own SWF shortly after Kuwait.

Might Roosevelt ever have anticipated the following from an official of the US government: the call by US Deputy Treasury Secretary Robert Kimmitt on oil-rich Gulf States, at the end of October 2008, to continue investing in the United States, to help restore financial stability.


And more recently, in November 2008, Gordon Brown, the UK Prime Minister, visited Saudi Arabia in talks to persuade Saudi Arabia and Qatar to invest more capital in the IMF, to create a larger pool of money that western, stricken companies/economies can draw upon.”We're looking for sovereign wealth funds to continue their more than five-decade track record of investing on sound commercial bases,” Kimmitt said during a visit to the United Arab Emirates, his second stop on a five-nation tour of Gulf countries and Iraq this autumn. ”If they do that - both in the US and elsewhere - I think this is how they can best contribute to the global economy,” he said.

Kimmitt, who travelled to the UAE from Saudi Arabia, said he was meeting government officials and investors in the region.
Unlike previous economic downturns that have come and gone, it is the stagnation in liquidity which has, via the world’s fearsome credit crunch, led to the falls in real estate values across the board to drop; highly-leveraged property companies have been squeezed while the values of commodities, in 2007, to mid-2008, have risen sharply. According to international property consultant CBRE, capital value for all UK property values in the UK have dropped by an average of 14.9% across all sectors as demand, especially for commercial property, has fallen.

It is these factors that have created an environment whereby cash is king: entities with high liquidity have been able to take advantage real estate opportunities - predominantly in the western world - where values have taken the sharpest plunge.


At the moment there is no other financial entity with as much liquidity - and the hunger to invest in real estate - as SWFs. Officially it is estimated that SWFs hold as much as $3 trillion-worth of assets and - although they are not as large as pension funds - they are set to increase their worth to around $12 trillion by 2012.

SWFs are state-owned investment vehicles that invest their surpluses in overseas markets. Not all SWFs are the same: each has its own agenda and strategy.

Some simply seek higher returns on their surplus capital, some seek to restructure and encourage domestic industries.

70% of SWFs derive their funds from oil and gas - therefore funds in Russia and the Persian Gulf (which is home to the largest SWF, called ADIA) have a vested interest in stabilisation funds that counter the volatility of sharp moves in energy prices. SWFs’ reliance on commodities also makes them seek to create long-term wealth and reduce their dependence on energy prices; this is especially evident in Dubai.

Other SWFs - such as those in China and Singapore, which are non-commodity-based - accumulate their wealth from trade surplus and foreign exchange reserves.

However one thing that all SWFs have in common is that they all de-leveraged their balance sheets during the early to mid-2000 global economic boom; as a result, these countries now have enormous buying power.

Hedging characteristic of real estate
Real estate has long been a hedging tool used by pension and insurance fund managers to help diversify portfolios; due to the characteristics of real estate - a long-term investment that can produce a steady income stream and capital growth; it is no wonder SWFs want to increase their exposure to this asset class.

With substantial SWF growth expected in the next four years it is neither sensible nor advantageous for SWFs to only invest in safe, fixed assets and securities. The Norwegian state fund has stated that it is receiving money at a rate of $1billion a week; ADIA, in comparison, accrues $1billion a day. With an income like that it makes sense for SWFs to diversify and increase their investment in uncorrelated asset classes such as real estate.

With China Investment Corporation (CIC)’s loss of around $1billion following its investment in US private equity giant Blackstone – plus the write-off of billons of dollars by Middle East investors who invested in American banks that fell victim to 2008’s credit crunch – SWF’s sentiment towards the US-Europe financial sector has changed: according to Monitor Group research, during Q2 2008, investment shifted away from financial services: in-fact half of deals completed by SWFs by value in Q2 were in real estate. Real estate was the asset class that witnessed the largest number of deals (12) during this period, with investment from SWFs totaling $13.7 billion.

Persian Gulf SWFs in particular have a huge appetite for global real estate; over the years they have compiled an impressive and prestigious global real estate portfolio preferring to invest in trophy and iconic real estate.

One of the largest SWFs - the Abu Dhabi Investment Authority (ADIA), which has an estimated worth of $875billion - in June 2008 took a 90% share in New York’s iconic Chrysler building, the second trophy building in New York City acquired using money from Gulf.

New York’s General Motors building, the most valuable building in the United States, was sold to a consortium of investors which included the Kuwait and Qatar investment authorities (the KIA, and QIA) for $2.8billion.

SWFs have been able to acquire much US real estate due to the weakness of the dollar and fears of falling office rents.

In Australia, ADIA also expanded its portfolio by investing $280 million in Lend Lease's new office-tower project, Darling Walk, on the edge of Sydney’s CBD.

In the UK, oil-rich SWFs from the Middle East spent £8.9billion on a cross-section of the real estate sector in 2007, which included office, retail and industrial property.

The UK has long been recognised as a politically stable and secure investment environment, delivering relatively stable returns from real estate investment. Subsequently, the KIA and the QIA have been attracted to the island shores.

In June 2008 the Kuwait Investment Authority’s property investment and development company - called St Martins - acquired the Willis Building in the City of London, for £400 million. Income stream and capital growth in the medium and long-term is guaranteed, complementing St Martin’s portfolio which also consists of London Bridge City and, in Turkey, the $515.5million, 420,000 sq metre Istanbul Cevahir, one of the largest retail developments in Europe, which it purchased in October 2007 from the Cevahir group.

In the UK foreign investors preferably work in JV in order to acquire and develop real estate. Partnering with host institutions, developers and landowners.

UK’s industrial warehouse market


Economic Zone World (EZW), part of the Dubai World SWF - which has a great deal of influence over the UK warehouse market – confirmed in Autumn 2008 it would pay £300m for Gazeley, Asda-WalMart’s development subsidiary, in March 2008. By acquiring Gazeley, EZW-Dubai World is able to expand much more quickly and increase its competitiveness.

Additionally under EZW, Gazeley will be able to restructure its warehouse development business model into one that resembles what has occurred in the US – i.e.: a ProLogis-style fund - into which it will place its investment properties.

The merger seems to have boosted Gazeley’s confidence in the UK; currently it has 2.5m sq ft under construction.

The effect on the UK of this rapid investment is that, at the time of writing, morale among property professionals has improved.

Oil and SWFs
Companies and funds based in the Persian Gulf and Russia have been able to acquire such iconic global real estate landmarks due to the price of oil: the price - which grew so much in 2006-2008 - has played a significant part in the strength of SWFs based in the Middle East and Russia. As oil prices soared to highs of $148 per barrel in mid-2008 a dynamic where emerging markets could reap massive profits from their natural resources was created.

While western economies and China have found in 2007 and 2008 that they have had to pay more for their energy, SWFs used this extra surplus margin to invest back into the market and acquire large stakes in foreign real estate and other assets.

In November 2008, however, oil prices dropped by more than 50%, to around $60 per barrel; this has - for the time being - brought a slowdown to the dynamic of enormous liquidity in the emerging markets versus the credit crunch in the West.

If oil prices continue to languish, it could slow cash inflows to oil-based SWFs. Iran's central bank warned in late 2008 that if oil prices fall under $60 per barrel, the country's oil-dependent economy could struggle to survive the world financial crisis. The same is evident for the majority of other commodity dependant SWFs.



Real estate in the UK and US

As a result of 2008’s intervention by SWFs, UK and US real estate - for the time being - has been able to maintain some kind of positive performance; there are still investors looking for, and acting upon, opportunities. This would not have been possible without SWF intervention.

Just as banks in the West have been shored-up by governments, SWFs have been able to shore-up the weakening real estate industry, albeit at the expense of a relatively significant stake in their original ownership; this has caused some controversy among those who feel that investment form a political state is unacceptable in a commercial market, permitting too much potential state influence in markets that would otherwise operate under objective market conditions. Currently the lack of transparency is also a concern.

Although SWFs are not a relatively new phenomenon their impact on the global markets is, nonetheless there is still scope to shape the ways in which they evolve. Management skills will no doubt improve. SWFs have not acted out of good practice since the conception of the first SWF in 1953. In-fact theoretically assumed geopolitical implications are the real sources of scepticism when you consider that in the wider scope SWFs are only 2% of the worlds $165trillion – worth of traded securities.

Abu Dhabi Investment Authority (ADIA) has started plans to enhance disclosure of its operations in line with an agreement with the IMF and the Norwegian State Pension fund is already practicing transparency.

There is no escaping the fact that forms of state ownership will become common place among companies, therefore it makes more sense to find ways of regulating this trend instead of ridiculing it.

The emergence of sovereign-wealth funds created by governments in the Middle East and Asia may well replace their forebears in helping to get the UK, European and US market back on its feet again.

The growth of Sovereign Wealth Funds (SWFs) is one of the most notable characteristics of the current wave of globalisation.

The Norwegian fund – called the Government Pension Fund (GPF) - recently announced that it is looking to invest around $13 billion into property – to gladden every property professional.

Back in London, Qatari Diar, an investment company of the Qatari government - wholly-owned by the Qatar Investment Authority - is another SWF that has been busy in the UK market. It has been involved in such prestigious London real estate as the Shard and Pinnacle Tower and in acquiring the highly publicised Chelsea Barracks site, an acquisition which would not have been possible without oil money.

In April 2007 Chelsea Barracks, a 5.2 hectare site, was bought from the Ministry of Defense by a consortium consisting of Qatari Diar and the CPC Group for a reported £959 million at the height of the property boom; it was initially put up for sale for £250 million.

As a result of the acquisition the site is currently owned by a company designated as Project Blue, a Guernsey-listed entity which is two-thirds owned by Qatari Diar and a third by the Candy & Candy’s headed CPC Group.

Under the arranged joint venture partnership, Qatari Diar is funding the development, while the CPC Group is responsible for management and design aspects.


However recent speculation has suggested that the Candy brothers are in negotiations to sell their share of Chelsea Barracks to Qatar Diar, because of the UK’s currently unfavourable economic conditions. It is unlikely that the development’s apartments will obtain the average £10 million each that was pencilled-in when the site was acquired.

Further west from Chelsea, real estate commentators have noted that the Abu Dhabi SWF, Mubadala, has funded its “green” energy subsidiary Masdar to acquire a 20% stake in a windfarm planned for the Thames Estuary in 2010; initially there will be 175 turbines – some of them no doubt sourced from the Finnish turbine manufacturer that Masdar co-acquired in 2007.

QIA is also involved in the PCP Capital Partners, a Middle East consortium that is currently in talks to purchase the property management, outsourcing company Trillium from Land Securities for around £1 billion.
Trillium manages more than 2,000 British properties, which include schools and hospitals on behalf of the Government, covering 50m sq ft. Acquiring Trillium would give QIA immediate access to secure long-term real estate assets under an already established and experienced company.
Conclusion

The ideal SWF model for investment into UK real estate, it can be argued, is to be found in joint ventures (JVs), whereby SWFs partner with financial institutions, developers and landowners.

At Chelsea Barracks, for example, a SWF has been able to supply cash to support the developer: SWFs can initiate real estate projects - in both the UK, and beyond - that would defeat rival, non-SWF entities.

SWFs are in an enviable position: currently with their “firepower” they can acquire real estate assets at below market value and use their partners to contribute to the project with expertise and local knowledge. In doing so, SWFs can successfully - and very profitably - build themselves out of the current downturn.

Notes:

A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments.

Sovereign wealth funds gained worldwide exposure in 2008 by investing in several Wall Street financial firms, including Citigroup, Morgan Stanley, and Merrill Lynch.

SWF’s were set up for numerous purposes, which include - and now control - around 2% of the world’s $165trillion-worth of traded securities

SWFs are not exploiting current US or European downturns. They have a balanced focus, which investigates opportunities in potentially lucrative emerging markets in the Middle East and Asia: investments in these regions accounted for 68 per cent of the total value of all publicly-traded deals in this mid-2000s.

Persian Gulf SWF’s have diversified global investment geographically, channelling liquidity into real estate and tourism projects in Morocco, Tunisia and South and East Asia.

However, although SWF investment in real estate equities will grow, the sector is not large enough to absorb much of their new investment in real estate.