In the second instalment of our review of Real Estate Capital’s biggest interviews of 2020, below are abridged versions of our interviews with the new head of Brookfield’s European lending strategy, the founder of a hotel property business, and the author of the biannual UK property lending report.
Martin Farinola, Brookfield
Despite the uncertainty caused by covid-19, some used this year to formulate or accelerate property lending strategies. Among them was big-hitting Canadian manager Brookfield, which hired Martin Farinola to grow its European real estate debt business. In August, we published our interview with him, which can be read in full here.
Brookfield’s North American debt platform was launched in 2004, but the firm only began to lend in Europe in late 2017 and has closed just three deals. Its purchase of a majority stake in credit-focused manager Oaktree Capital in March 2019 brought significant exposure to the real estate debt.
However, Brookfield now plans to grow its in-house European real estate debt platform, which the organisation stresses is operated entirely separately from Oaktree. In June, it hired a sector veteran, Martin Farinola, to spearhead its European lending drive. Farinola led the property lending arm of Swiss asset manager GAM, which bought the real estate finance business of independent manager Renshaw Bay, in which he was a partner, in 2015.
Speaking to us via videolink from his Canary Wharf office, Farinola admits he is still getting to know the organisation. But he is clear on the task ahead. “Our ambition is to grow a scalable business here in Europe,” he says. “After completing our first few deals in the UK and on the continent, I was hired to help lead the expansion and increase our footprint in Europe. Sitting in the same office as our equity team has helped me ramp up quickly on Brookfield.”
In 2017, Andrea Balkan, managing partner of Brookfield’s New York-based real estate group said European lending would initially be done through the $3 billion Brookfield Real Estate Finance V, which closed in November 2017, with a net 9-10 percent return target. Up to 20 percent of the fund was allocated to Europe and Farinola says it is still being deployed, with “several hundred million” available to invest.
The size of the loans Brookfield is aiming to write suggests a significant commitment to the strategy. Mezzanine loans could start from $20 million, with whole loans from $75 million, of which the senior strip can be sold on to traditional lending partners. Development finance is also in the company’s sites.
“The simplest way to put it is, given the size of Brookfield, it’s probably what you would expect us to be in European real estate debt,” says Farinola. “The size of our equity platform in Europe lends itself to us having more of a debt offering and is complementary. Our financing capabilities in North America are large and our ambition is to replicate what we have in the US here in Europe.
“We want to be able to offer investors the ability to invest across the capital stack, including lower-return lending as well as medium and higher-risk. In our mezzanine debt funds, we are looking to generate strong risk-adjusted returns by providing loans on high-quality real estate assets at a discount to the intrinsic value of the real estate.”
Farinola says Brookfield will provide leverage within the 70-75 percent loan-to-value range, or 65 percent loan-to-cost in development financings.
“We see debt as a more conservative alternative to equity,” he explains. “As an owner and operator of a large amount of real estate, we understand it, so we won’t take unnecessary risk in lending deals. We are not a loan-to-own lender. We are trying to make sound real estate investments. I’m an optimist in the overall macro-environment. But, as a lender, I always need to be pessimistic and take a conservative view.”
But why is Brookfield doubling down on debt now?
“A lot of the traditional lenders are diverting capital towards helping their clients and are dealing with loans on their balance sheets that might not be performing too well in this environment. These traditional lenders have reduced their LTV levels, so there is a need for lenders to provide top-up capital to sponsors or offer whole loan solutions.”
Farinola says he is one of the industry’s optimists and does not agree with those who think covid-19 will be a gamechanger for real estate.
From a finance perspective, he argues the existence of alternative lenders in Europe will help avoid a repeat of the liquidity drought seen in the wake of the global financial crisis.
“Bumps in the road caused by this crisis, or Brexit before it, make borrowers call into question the certainty of execution in some of the finance markets. So, they look to alternative lenders to help smooth the bumps. For alternative lenders with dry powder, this is the time to seize the opportunity.”
Rishi Sachdev, Shiva hotels
One of the real estate sectors most impacted by covid-19 was hospitality. In August, we published our interview with Rishi Sachdev, founder of Shiva Hotels, on the availability of finance for businesses like his. The full interview is here.
How has the crisis affected the availability of hotel debt?
There are fewer active lenders, and their willingness to lend is more restricted. From the conversations I have had, high street banks are focusing on their existing clients and facilitating government-backed loans. Alternative lenders, especially debt funds, understand the sector and are more open to providing finance, but more selectively and with a greater focus on assets’ location and borrower quality.
How have debt terms been affected?
Lenders are generally more cautious and are taking less overall exposure to the sector. Terms are obviously dependent on the individual deal. However, there are still lenders willing to finance hotels, including mezzanine and preferred equity providers. In some cases, they are charging higher margins, while in others, their cost of funds appears similar to pre-covid levels. Overall, though, they are more conservative, including on leverage.
Is development finance scarce?
In some cases, lenders are more comfortable funding development than financing existing operational assets. Our current schemes will not complete until 2023, so although there are challenges to financing construction, some lenders see them as more manageable than the short-term challenge to operational assets. Development facilities are being structured with contingency for disruptions to timeframes.
Nicole Lux, the Business School, City, University of London
In October, we published our interview with Nicole Lux, senior research fellow at the Business School at City, University of London, and author of the biannual UK market lending report published by the school. The full interview is here.
Real estate lenders in the UK proved most willing to finance residential assets during the first half of this year as they took a defensive approach to the market, according to the author of the biannual UK lending market survey published by the Business School – formerly Cass Business School – at City, University of London.
Nicole Lux, senior research fellow at the school, spoke to Real Estate Capital on the occasion of a webinar on the property market’s debt funding gap, hosted by law firm Dechert.
Lux says the research showed 29 percent of total new debt originated in the UK in H1 was allocated to the residential sector, with 18 percent written against development schemes – accounting for £2.5 billion (€2.7 billion) and £1.5 billion, respectively, of the UK’s total £15.5 billion origination during the period.
“A lot of lenders have been focusing on residential, both investment and development, because it has been seen as a defensive bet during covid-19,” she says, adding that private rented sector assets proved particularly popular with debt providers.
Lux says offices were the second most popular property type for lenders during the period, accounting for 24 percent of new loans. The sector remained the mainstay of senior lenders’ activities, accounting for 57 percent of German banks’ new UK lending and 49 percent of insurance companies’ origination.
“Most lenders are staying away from retail. They are not financing new loans, although the current exposure to the sector has not come down,” Lux says.
She explains that outstanding loan amounts allocated to the sector have remained stable, due to lenders extending existing loans that could not be repaid or refinanced elsewhere.
Lux says lenders’ willingness to write new loans will be highly dependent on asset types and locations. For example, interest in secondary assets has dwindled overall. Logistics and industrial assets are lenders’ preferred option, regardless of location, when considering new financing requests, she adds.
Lux says that, according to data provider REMIT Consulting, only £1.6 billion of a total £2.3 billion of rent due across all sectors in Q2 has been collected. She adds that the total rent due corresponds to £1.6 billion of interest due to lenders, of which 43 percent is to be paid to UK banks.
“We have made calculations on interest payments because lenders will, at some point, be affected by landlords’ inability to collect rent. Interest coverage ratios were very high so, in theory, they should be fine if rent was collected, but that has not always been the case.
“In the logistics sector, for instance, only 52 percent was collected by landlords in Q2, according to REMIT, which puts pressure on interest coverage ratios.”