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Merlin CEO: Political risk preventing investors from backing European expansion

? MERLIN Properties will not be expanding beyond Spain and Portugal in the near future as political risk creates caution among investors, Vice Chairman and CEO Ismael Clemente said.

? He does not see the Spanish real estate investment trust market producing another company like Merlin until the next cycle, as assets are now too expensive.

? Spain should deregulate local insurance companies' access to the real estate market to address listed property companies' reliance on foreign capital, he said.

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Ismael Clemente
Source: Merlin Properties

Clemente has more than 20 years' experience in the real estate sector, working at Garrigues, DB Real Estate and RREEF. S&P Global Market Intelligence spoke with him prior to the resignation of Spanish Prime Minister Mariano Rajoy on June 5, which led to a minority government led by the country's Socialist Party coming to power. What follows is an edited transcript of the conversation. Ismael Clemente is vice chairman and CEO of Merlin Properties, one of Europe's largest REITs, with a market capitalization of approximately €5.6 billion and a gross asset value of €11.4 billion. The company was founded in 2014 and has since gone on to amass a portfolio of office, logistics, and retail assets across Spain and Portugal.

S&P Global Market Intelligence: Merlin has grown at a rapid rate since it was established in 2014. Where do you see its future growth coming from?

Ismael Clemente: What we hear from our investors is that they don't want us to do their jobs in terms of country-risk allocation. If we were to go out of Spain [and Portugal], investors wouldn't like it, at least at the moment, because the biggest risk in the mind of international investors nowadays, in Europe and probably elsewhere in the world, is political risk.

A U.S. investor told me that it is quite difficult for a CEO to ruin a business because the number of controls, checks and balances that a company can action before [a business is ruined] normally prevents that from happening. However, they said that the probability of being completely screwed up by an idiot politician is extremely high.

Ideally, what my investors want me to be is a single-market [with Spain and Portugal constituting the Iberian market], single-asset vehicle. From an imperfect standpoint, they accept Merlin as a single-market, multi-asset vehicle, provided "multi" doesn't mean too many different asset types. In our [IPO] prospectus, we told investors we would do retail, offices and logistics, and we need to stay true to that. We don't want to be seen by investors as empire builders.

Merlin is perhaps Spain's only major success story since the country changed its REIT legislation in 2012 to attract more investment. What are the prospects of another Spanish REIT achieving Merlin's size and scale in the near future?

At present, it's not that easy because in the end we are sons of history. The way we have built our company in many aspects owes its success to the timing of the market. We started accumulating assets in 2014, and we were quick to accumulate lots of assets of high quality between 2014 and 2015. Then we moved on to the second phase of our expansion that involved corporate acquisitions.

If you try to repeat that in today's market, which has turned clearly from having been a buyer's market into a seller's market, it would be first much harder and second much more expensive. So many other companies can do what we have done but they probably need to wait until a future down-cycle because otherwise it's going to be really painful to build up another company with €11 billion of assets like Merlin in today's market.

One of the factors perhaps limiting the growth of the listed Spanish real estate sector is its heavy reliance on foreign capital. What measures would you suggest that might help attract more local investment?

The first thing that would be necessary to do in Spain is deregulate the access of locally established insurance companies and pension funds to real estate — unlock their internal sources of capital. It consumes twice the capital in an insurance company in Spain to buy real estate indirectly through a liquid REIT than directly acquiring one asset. They never compare with the type of performance you can obtain through direct investment in real estate through a REIT.

The second thing that would be a major development for the market would be to polarize investment in all sorts of listed companies, but specifically REITs. All of the REITs that have been floated in recent years, because of the stupidity of MIFID II, have gone to the market only with institutional tranches; none of us have placed any shares with retail investors. Your lawyers tell you, "You don't want to place shares with minorities because if you place with minorities [and] things go badly, you are going to be sued for no reason." Simply to screw you up and try to get some money out of you from a class-action suit.

Consequently, there's been no placement with the general public. We are happy with the way our number of shareholders is evolving but to get a decent shareholding base of half a million will take [a very long time].

As the CEO of Spain's largest listed property company, what economic policies would you like to see the Spanish government introduce that might help boost investment in the country's real estate sector?

The problem in Spain, as in many other places in Europe, is that there is a permanent crowding out effect of the private sector by the public sector. The debt the private sector is issuing always has a rating that is at best equal to sovereign debt, [but usually below]. What they do is screw up the private initiatives because clearly they have a better credit rating owing to their condition as a sovereign, which is something that you cannot compete with.

That also happens in equity. The problem is that government social security needs people to continue spending their savings every month through a contribution-distribution system. That means there are very little savings that the average Joe or Mary can afford to make on a monthly basis [and] a company's potential source of equity — which is the savings the Joes and Marys could invest in your capital in order to receive a relatively safe, predictable, stable dividend — is lost.