AWA: Academic Writing at Auckland

Question 1: The firm that Dan Bowden represents is AXA, originally AXA is an insurance firm, providing insurance for cars, homes, and liability insurance. Within AXA there is an investment management sector and within this sector is the alternative real estate business line established in 2007. The alternative real estate business line includes everything outside four main food groups of real estate (industrial, retail, residential and offices). The sectors include healthcare, hotels, self-storage, data centres, student accommodation, hotels, automotive and real estate. The general strategy the firm employs for investment decision making is anything not done by others or difficult for others. The company focuses on needs based real estate as opposed to wants and uses demographics to identify which investments have a long term requirement. That is regardless of market conditions such as the GFC and Eurozone crisis there is still need for these investments this includes care homes and petrol stations. The development and market movements of the alternative real estate market are what drive returns.

Other strategies include a BETA investment strategy which is where volatility and risk of a security or portfolio is assessed in relation to the overall market. It differentiates good and bad investments[1]. As opposed to the Alpha strategy which is which doesn’t account for the up and downs of the market which is important to AXA and alternative real estate as it’s highly dependent on the market[2].  Liability matching ensures sales of assets and income streams are timed for future expenses. As AXA is an insurance firm that has pension funds, & life insurance they need to generate returns and their alternative real estate investment strategy is structured around meeting these returns. The timing and value of pay-outs may vary[3], so their investment strategy & profiling of debt fits around this. AXA mainly uses core plus strategy where private equity funds invest in moderate risk real estate that provides moderate returns[4].

For the past five to six years AXA have been using debt tranches to invest in real estate due to the GFC/Eurozone crisis. This is where mortgage backed securities are backed by mortgage pools comprised of different types of mortgages. Each mortgage varies in duration and derives different profits[5]. Debt is on the first tranch of capital and has a very low risk profile. The advantages of debt tranches are that allow for customization of investment strategies and are attractive to investors, which is beneficial for AXA as 50% of capital is derived from third party capital such as private individuals.

Question 2: Overall constraints in achieving their chosen investment strategies are constraints on leverage and how to use debt. This decision is made by the AXA investment committee for the alternative property income venture, it is 80% LTV on any one particular asset and 70% at portfolio level. Because of the specialist nature of alternative real estate there is high levels of risk and specialist due diligence is required. Different properties also present different risks for example Swedish police stations were sold to on double net lease which exposed AXA to structural costs. The economic conditions made it difficult to procure debt, due to the GFC and Eurozone crisis. The Swedish government was also going under, and markets were driven by fear.

Properties were predominantly offered though share deals, common in Europe. This brings with it liabilities as any actions of the company are the responsibility of AXA even if AXA wasn’t involved at that particular time they will have liability. The European alternative real estate market has many risks; markets are illiquid there are very few transactions in this market. It is impossible to find comparables and valuations were based on estimation. The market is also very opaque and there was no transparency or disclosing of information. There was also limited expertise as there were not many real estate experts on brokerage and valuation side to converse with and get advice from. Because one of AXA’s strategy is core plus, they require some additional capital and value add for example with the Port Frejus Hotel a 106-bedroom hotel was converted into 116-bedroom space by utilizing disused space[6]. 

The properties are designed and created specifically for one purpose only. This has an issue of obsolescence and impacts on the operating efficiency and rent generating potential of the property which ultimately affects the returns/profit for AXA. The European market also has numerous regulations such as environment regulations and tax regulations such as France which changed their tax regulations meaning AXA had to pay tax on based on gain in book value because of improvements made to their Hotel in Port Frejus.

Question 3: The properties presented were the Swedish police station portfolio, Port Frejus, Elbe portfolio, Eroski petrol station portfolio. These properties fit into AXA’s strategy of needs based strategy, regardless of the economy people will still need to go into care homes and have use for petrol stations. The risks of the properties are the specificity and building condition (obsolescence). The rental risk is influenced by obsolescence and European market conditions and regulations. As one of AXA’s strategies include liability matching, alternative real estate investments are one of the fast growing segments in alternative real estate and provides consistent returns in the medium to long term which can potentially help institutional investors such as AXA meet their rate of return. Investing in alternative real estate also helps AXA diversify their portfolio and improve returns and one of the investor[7] controls are that a maximum of 20% of equity can go into any one investment.

The Swedish police station had an IRR of 36% which exceeded AXA’s aim of 9% IRR and a distribution income of 7%. The Eroski petrol stations had an IRR of 30% and a distribution income of 7% which also exceeded AXA’s IRR of 12% for this project. The care home (Elbe portfolio) also did reasonably well with a IRR of 9% however there were risks due to improper due diligence undertaken on the tenant, this can be attributed to a lack of transparency and information from industry experts. The hotel in Port Frejus was a loss and it had and IRR of -6% as due to the GFC/Eurozone crisis the occupancy rates were low as people stopping visiting the hotel and as a result of poor due diligence, water leakage in the carpark cost $4 million to remediate.

Question 4: The target IRR for the company is 12% which is achieved through a blend of income and capital returns, and this is determined through AXA’s strategy and investment committee. IRR also has a geographic focus with for private equity real estate funds, the mean target IRR for Europe based funds is 13.8% so 12% IRR is appropriate in this case. The IRR for the properties presented was determined through KPI’s because alternative real estate has specific risk, the core markets are used as comparables and there is an aim of getting a premium over and above this (in the context of 12%). It is also achieved through detailed financial due diligence and modelling which informs AXA of how to invest in the asset. The asset management objective improving assets through cap ex and repositioning assets results is a 12% Net IRR. 

Question 5:

1. Rents: Optimal rent revenue is gained from selecting tenants through a strict due diligence process. However rent in the long term may be difficult to obtain due to economic conditions such as the GFC/Eurozone crisis. The quality of the asset may also affect the rent generating potential.
2. Vacancy Risk: Vacancy risk is relatively low in the long term as clients are considered stable long term tenants with long lease terms. However a downturn the market can affect occupancy rates as result of the GFC/Eurozone crisis,
3. Possible non-recoverable outgoings: Non recoverables are mostly management and these include the due diligence done the properties which is approximately $120,000 to 130,000, and any education costs for the team on how to raise debt. Other non recoverables can also be related to the obsolescence making assets not economically viable.
4. Obsolescence / Depreciation: Social, functional & obsolescence affect properties, in particular assets are designed and created specifically for one purpose only. This impacts on the asset, by affecting the rent generating potential of the property. E.g. The German care home rules had changed requiring 3 nursing stations, originally the tenant had an inefficient shape of building. AXA mitigated this by altering the shape of the building to a cross shape which enabled more people to be served. This lead to the tenant having much more efficient operation and pay a higher rental, resulting in a more stable business and AXA can charge more rent.
5. Going-in and Going-out Capitalisation Rates (reversion value): properties are sold for a higher value due to improvements but maybe affected by the GFC/Eurozone crisis and have lower values such as the hotel in Port Frejus.
6. Capital Expenditure: Focused on obsolescence and value additions. Since AXA is the fund manager, asset manager and entity manager it is their responsibility to ensure assets are reliable (e.g. data centres) and economically viable to ensure AXA has sufficient rent generating potential to meet their returns.
7. Debt / Gearing: AXA has a strategy of investing in a debt tranch and debt is difficult to procure as a result of the GFC crisis/ Eurozone. As a result of the rules and regulations there were breakage costs on debt for the police station and held for a further two years.

At AXA real estate. The investment committee, places constraints on what kind of leverage and how to use debt.

Question 6: For AXA the cash flows are assessed separately and for each of the properties. For Hotels the cash flows are occupancy levels, ADR (average daily rate, room rate and operating department. The fund level cash reflect what is happening a property level and are what investors receive after interest, taxes, net working capital, capex, debt drawdowns (repayments), etc. is paid.

Question 7: The presentation incorporated obsolescence as an overarching driver of cash flow analysis this is because obsolescence is detrimental to all of AXA’s portfolio and all the properties mentioned. Obsolescence is an important risk as the buildings have very specific risk. For hotels it would be social obsolescence the lobby area which is influenced by social and fashion trends in the market. The facilities and buildings will need to be constantly refreshed otherwise they can risk becoming obsolete and vacant which affects AXA as they are not able to meet their investment returns.