In the current low interest rate environment, with uncertainty over the future course of inflation, there is naturally an appetite for real assets which can also provide meaningful real returns. However, real asset investments can be inaccessible to most investors.

Real estate therefore offers a more familiar exposure to the benefits of real assets in today's world, explaining its particular popularity since 2008. However, the normal relationship between risk and return applies to real estate investments: exposure to interest rate volatility, unemployment and overcrowded markets imply as much uncertainty in real estate as in any other sector.

In selecting our specific focus within the real estate sector, Arsago has therefore cencentrated on minimising the known risks and seeking out value dislocation which, with careful and creative application, offers superior returns with below-average levels of risk.

Spanish Real Estate

The path of recovery

Over the past few years, Spain has distinguished itself as having proved that Europe's orthodox response to the crisis works. Austerity, discipline and the readiness to absorb short-term economic pain for longer-term gains in competitiveness is slowly working out and reforms are bearing fruits. The country has had six quarters of economic growth, unemployment is falling faster than expected and confidence and investment have both started flooding back.

After slowly absorbing the large overhang of unsold housing mainly in the coastal region the recovery in the real estate sector is now underway in the capital of Madrid, Barcelona and the Basque country. New capital from abroad and recently also from domestic investors is flooding back in to the market, targeting on the primary areas of the major cities.

Why the timing for investing is important?

The economic cycle is anticipated by economic players to return to moderate growth by 2015. At that point occupancy rates will have recovered, with a likely impact on rents and capital values. A more deleveraged financial sector is starting slowly into a new credit cycle with new construction and acquisition financing available in the prime property segment.

Capital values have fallen more rapidly than rental values, enabling investors to benefit from increased yields. This provides opportunities for investors seeking to exit in three to five years, as continued economic recovery will push up property prices.

Real estate developments in prime locations have benefited from increased foreign and domestic demand recently, resulting in higher capital gains than in previous years. In Madrid and a few other Spanish cities, demand for high end property has always been more stable than in the rest of the country. Recent increase in risk-adjusted returns have attracted renewed investor interest. In Europe as in the rest of the developed world, investment yields are low. As a result, investors have increasingly turned their focus to real assets and especially to high end properties in the major economies in Europe. In Spain, with the recovery underway, this trend has started to gain momentum and entry levels are attractive.

Why we focus on Madrid?

Madrid is the main business and financial center in Spain, as well as the most international city in the country. The city is one of the most visited capitals in the world with more than 15 million overnight stays. Two of the leading and globally top ranked Business School are located in Madrid. The city started to attract foreign buyers in the upper end of the residential property market and in the retail sector. The most attractive areas for the retail sector are in the so called "Madrid Golden Mile": Calle Serrano, José Ortega y Gasset, Gran Via and Calle Preciados. These areas, which are the predominant shopping and tourist attractions are currently going through a mayor urban redevelopment program initiated by the municipality of Madrid. This should lead to substantial capital appreciation over the next years.

Main reasons for investing in the Spanish real estate market:

  • The low interest rate environment created a property boom in Europe's major capitals. Prices in these locations have reached pre-crisis levels with yields falling to historic lows. Madrid has been lagging this trend and started now to catch up from much lower price levels
  • The Spanish unsold housing stock is slowly decreasing; in larger cities, availability in prime areas is becoming tighter since almost no new construction took place over the last few years
  • After halting loans to the construction sector for many years, banks are now slowly starting a new credit cycle, with construction and acquisition financing becoming available for selective developments, mainly in prime locations
  • The economy seems to have passed the trough of the contraction cycle and started to grow slowly again
  • Strong inflow of foreign capital through foreign direct and property investments
  • Madrid, as the capital and main financial city, has already started to bounce back to more balanced growth
  • Property in prime areas of Madrid is in growing demand and prices have started to rise. Timing to enter is attractive and momentum is building

German Real Estate

Europe's economic power house

Germany is a political and economic fortress of stability in a continent of broad diversity. Compared to other European countries Germany is characterized by a federal and polycentric structure. There are no overwhelming metropolises that clearly dominate the country. Instead, there are several dozen cities with economic impact.

In the course of the continuing low interest rates, the average returns in the top 7 primary cities have decreased significantly. Therefore we are extending our focus to cities from the second row (secondary locations) with a greater chance of positive returns.

We approach the German market through our local partner Arsago Real Estate. It initiates private equity funds with a strategic investment approach for the German residential property market. The firm also provides asset management services of residential property portfolios for institutional investors.

In 2004, the first successful launch of a residential property fund was carried out with Morgan Stanley Real Estate Fund (MSREF) for institutional investors and total investment was approximately EUR 700m.

Arsago covers all areas of implementation of real estate investments: from the beginning stages of investment strategy identification, purchase financing, controlling and reporting to the very final step, which consists of the sale of real estate.

Arsago often makes investments in a niche, where investments are too large for private investors and too small for institutional investors. In the past two years Arsago managed two projects in this niche with investments between EUR 15m-20m per project.

Brazilian Real Estate


At 33.6% of GDP, Brazil's low level of net debt together with high interest rates are in stark contrast to the majority of developed and emerging economies. A burgeoning middle class, a deficit of 5-6 million units and powerful demographics provide a solid platform for housing: population is forecast to rise from 194 million to 209 million by 2020 while the rate of household formation is forecast to grow three times faster over the same period, from 64 million to 80 million. 1.88 million new units are required annually to meet new demand and erode the deficit by the target date of 2020.

This pent-up demand has resulted in the launch of a government-sponsored housing programme, with 3 million units budgeted to date and a further 3 million units recently announced (tbc). It is the single most popular government programme. A change in the mortgage law in 2005 unleashed further pent-up demand by enabling a proper foreclosure process and jump-starting the mortgage market; however, even today, mortgage financing represents a tiny 7% of GDP, a fraction compared to most developed countries. This switch from a 100% equity financed housing market to one based on debt financing has prompted a one-off jump in house prices. However, housing has returned less than the yield on the overnight rate over the last 10 years, underlining that recent growth represents no more than a catch-up with demand. See a specialist Fitch panel on Brazil discussing the health of Brazil's housing market: External Link

Value dislocation: a little-known facet of Brazil's financing system

Arsago focuses on development of residential housing using the unique "associativo" financing system. The system was introduced in 2005 and is administered by two state-owned banks. Purchasers buy off-plan with 10-20% deposits and are subject to rigorous credit checks before receiving mortgages, which are used to pay for construction on a monthly basis. This means that equity from the developer/investor is required to pay only for the land (typically 65% of equity) and certain pre-construction expenditures. Total equity requirement is around 10% of final sales revenues. The associativo system requires minimum pre-sales equal to the breakeven development cost before construction can begin. So investors' capital at risk is effectively confined to 1/3rd of total equity and there is no commitment to build prior to pre-sales, after which the developer's/investors' risk is largely eliminated as their role reverts to that of a contractor. Returns benefit from the leverage supplied by the purchaser. Moreover, cash distributions begin within a month of the start of construction, boosting IRR and reducing risk. Arsago further optimises the investment by re-investing these early proceeds into new projects, thereby increasing returns without any additional risk to the original risk capital.

Sao Paulo state is the economic hub of Brazil and home to the largest concentration of multi-national firms and universities, with one third of national GDP and some of the fastest-growing cities in Brazil. The location of the development projects is confined to a 150km radius from Arsago's central Sao Paulo office, staffed by an experienced project manager and a specialist Brazilian real estate lawyer. Arsago has formed a close partnership with a Sao Paulo-based developer over the last three years, whose directors have a total of 50 years in the real estate and financial industries and have successfully delivered over 8,000 units over the last 30 years. A further 2,500 units with an aggregate sales value of R$ 500 million are currently under development. Arsago targets the socio-economic "sweetspot" of households with an income of 6-12 x minimum wage.