Real Estate Firms Confront the Challenge of Diversification
Diversify or die. That is the motto that Spanish real estate developers have adopted for their strategy. For years, the Spanish real estate market has been growing at a rapid rate. Between 1993 and 2003, some 800,000 housing units were constructed every year, raising the country’s stock of housing by 125%. Property prices have also risen. During the third quarter of this year, the average housing unit rose in value by 13.4% to reach an average of 1,781.5 euros ($2,149) per square meter.
Although those numbers are getting out of hand, real estate developers know that the trend can move into reverse. Forecasts for the upcoming year call for prices to rise between 8% and 10%, according to CB Richard Ellis, the real estate consulting firm. In addition, it is now taking longer for firms to sell housing units.
To avoid surprises that have a negative impact on their bottom line, real estate companies are looking for alternative strategies.
The Case for Foreign Markets
One strategy is to move into foreign markets. The trend toward globalization is intended to diversify risks, and it reflects an eagerness to grow. The exceptional condition of the market over the last five years has generated the liquidity required for investments, and it is enabling this growth. “During the last four years, the real estate firms have made a lot of money, and they have to move it somewhere,” notes Emilio Langle, director of residential properties for Aguirre Newman, the real estate consulting firm.
“The growing globalization of Spanish real estate is based on three pillars,” says Pedro Viňolas, who heads the real estate department at the ESADE business school. “First, there are some factors related to the size of the market. For example, the Barcelonaoffice park has four million square meters; the Madridpark has 14 million square meters; and the Parispark has 40 million square meters.” Viňolas says that diversification of risk is the second factor. “These years have been very good but will things continue to be so in the future? The third reason is that countries like Francehave the sort of tax system that does not exist in Spain. In France, publicly traded real estate firms are exempt from certain taxes. Those kinds of tax advantages drive companies into foreign markets,” notes Viňolas.
José Luis Suárez, a specialist in the real estate market at the IESE Business school, adds a fourth factor: “Spainis a very fragmented market, and it is very hard to gain market share.”
There are several formulas for moving into foreign markets. First, some real estate firms, such as Metrovacesa and Colonial, have opted for the riskiest strategy. They attack foreign markets by acquiring local companies, despite the major outlay of funds required. The advantage of this approach is that they assume full control of the local company.
Along those lines, Inmobiliaria Colonial took its time looking at opportunities in foreign markets before deciding on Société Foncière Lyonnaise (SFL), based in Paris. Colonial paid 1.558 billion euros ($1.88 billion) for that French company, which has 475,000 square meters of space in 39 office buildings in the French capital. For its part, Metrovacesa, the giant Spanish firm run by Joaquin Rivero, followed the same approach, paying 5.5 billion euros ($6.63 billion) to acquire Gecina, another Paris-based real estate firm. Analysts have generally applauded both deals but there have been some dissident voices. According to professor Manuel Becerra, who specializes in globalization at the Instituto de Empresa business school, “Metrovacesa paid a premium of 12% for Gecina. But the Spanish company is not going to contribute anything new to the French market, so it will be very hard for it to recover that premium.”
Other real estate companies have opted to purchase buildings outside Spain, restore them, and modify the way they are used, while keeping them under their ownership. That’s what happened at Renta Corp., which owns buildings in Parisand London, and at Restaura, which has bought several buildings in Paris.
The least risky strategy is to form a partnership with local companies. “One approach isn’t necessarily better than another,” explains Viňolas. “It all depends on what skills the company has, and the added value that it can contribute in the foreign country. However, the strategy I recommend is to work under a local partner who can minimize the risk.” Other experts agree. “The best thing to do is to go in with someone who knows the market, has a relationship with local authorities and knows the rules of the game,” says Suárez.
For Becerra, the most important factor is the nature of the real estate project. Becerra argues that companies like Fadesa are going to succeed outside of Spainbecause they are developing large-scale residential and tourism projects that attract millions of foreign tourists. Fadesa has acquired Financiere Rive Gauche, a French real estate firm developing several resorts in North Africa. One of those is Saidia. Situated on the Mediterranean[in Morocco], the project covers an area of seven million square meters, and it will include seven hotels, 3,000 housing units, a health clinic and a heliport. The total cost will be 1.5 billion euros ($1.8 billion). In addition, the company is developing another multi-purpose project in Tangiers [Morocco] for both the residential and tourism markets. And it has just won a bidding contest to build a resort in Agadir [Morocco].
Where Are We Going?
These days, the main destination of Spanish real estate firms is Eastern European countries such as Polandand Hungary. That market, recently brought into the European Union, offers attractive property prices and low labor costs. The housing market has especially great potential in Poland, which has a population of 40 million. That’s why Polandis one of the Eastern markets exerting the strongest pull on Spanish companies. For Viňolas, “Entering the countries of the East is riskier than in the rest of Europe. However, the advantages stem from the greater room for growth in these economies, especially after they joined the European Union.” Adds Becerra: “The Eastern countries are going to be attractive for the next ten years because prices are very low there. In Bulgaria, for example, you can find very good houses for 4,000 euros ($4,825).”
Experts agree that the risks are in the region’s legal and institutional frameworks, which lack the consistency of the West, and the financial disadvantages that result from the fact they have their own currencies. “It’s the same thing that happens with investment in Latin America,” notes Viňolas. “The main problem in these countries is that the local currency depreciates.”
A long list of Spanish companies are in Eastern Europe -- Fadesa, Ferrovial, Riofisa, Hercesa -- and many other companies have their eyes firmly focused on the market, awaiting the right moment to jump in.
The Closest Market
“Spanish real estate markets are going into foreign countries to acquire scale. The problem in the Portuguese market is its small size,” explains Viňolas. “Not only that, but sometimes it is not worth the effort to get to know a new market if you wind up with only a small share of it.”
Ferrovial is one of the Spanish companies with the longest history in Portugal. It entered that country in 1989 as a property developer, and it has a portfolio of a thousand buildings there now. The Prasa group moved into Portugalfive years ago, with the goal of operating in the Algarveregion. It is now constructing five properties. In addition, Prasa, based in Cordoba, signed an agreement last year to acquire Lusotur Inmobiliaria, a Portuguese tourism company, for some 380 million euros ($458 million). The deal gave Prasa control of the Vilamoura complex, site of the upcoming Vilamoura XXI project, which will cover 900 hectares (2,223 acres).
The latest company to enter Portugalwas Urbis, which has a presence in Portugalthrough its subsidiary, Euroinmobiliaria, and enough property in its portfolio to handle 1,000 housing units. Hercesa has also moved into Lisbon, and it wants to gets its feet wet in Porto.
Incursions into Central and South America
When it comes to investing in Latin American real estate, Suárez cites three problems. “It is a riskier investment, even though the expectations about profitability are high,” he notes. “Second, when you want to buy property, you don’t know as much about the market. Third, it is harder to imagine how things will develop in Latin Americain the future as a result of all that.”
According to Viňolas, this is such an enormous market that it has to be considered segment by segment. “Whatever commitment you make must be carefully calculated.” Nevertheless, he believes Mexicois a less worrisome proposition for real estate firms [than other countries in Latin America] because operating there means working within the NAFTA pact.
Already, such Spanish real estate firms as Lar and Anida, which belongs to the BBVA bank group, are active in Mexico. Lar has ties with a Mexican real estate group, and it expects to construct 5,000 housing units over the next five years. Anida has created three subsidiaries in Mexicothat will try to forge alliances with local companies in an effort to get projects up and running. Another company active in Mexicois the Mall group, which has invested 240 million euros to develop a complex aimed at both tourism and residential use. It involves the construction of 2,500 villas, a five-star hotel, a marina, and a golf course.
For Langle, the most secure destinations for investment are the Caribbean, Morocco, Miamiand the Dominican Republic. “All the big Spanish real estate developers are moving into Miami.” However, he does not overlook the possibility of investing in Latin America, where occupancy rates are high and profit margins are above 7%, something “unthinkable in Spain.”
Will Spanish real estate developers succeed in foreign countries? “To succeed in a foreign country, it is not enough to know how to do things well in your own country,” notes Becerra. “That’s especially important if you consider that real estate development is a very local kind of business. For example, Wal-Mart enjoys great success at home but it has had lots of problems in Germanyand Indonesia-- from which it had to depart. The really important thing is that your business must be exportable.”