The news that alternative lender Starz Real Estate successfully launched Europe’s first commercial real estate collateralised loan obligation of this cycle is hugely significant for the European commercial property lending market. Indeed, if this financing structure is embraced to anywhere near the same extent as we have witnessed in the US, the European CRE lending landscape should be set for a profound and positive transformation.
Broadly speaking, a CRE CLO is a capital markets instrument created by the securitisation of loans secured by CRE. More specifically, as with commercial mortgage-backed securities, this entails a shell company acquiring a bunch of loans secured by CRE which it finances through the issuance of rated notes into the capital markets.
On a macro level, CRE CLOs and CMBS share a lot of the same characteristics given that, in both cases, their underlying collateral are loans secured by CRE. However, it is only when you drill into the structure itself that the distinguishing features become more apparent.
CRE CLOs differ from CMBS in several key areas. First, they have note protection tests. Second, they feature retention of equity by the sponsor. Third, and perhaps of most significance, they feature an operating adviser. The operating adviser is not only the eyes and ears of the securitisation with respect to the underlying loans; it also has an active role in dealing with amendments, waivers and consents. Its role also involves exercising extensive consultation and consent rights regarding the management of collateral, including the ability to sell loans under certain circumstances.
This suite of rights enjoyed by the operating adviser enables the original lender – despite these deals being securitisations – to retain an ongoing relationship with the borrower. This means that, unlike traditional CMBS, these structures are well suited for financing more challenging transitional real estate. At the same time, from an investor’s standpoint, they get additional comfort that from day one there is a counterparty not only performing this operating adviser function but also a counterparty with which its interests are aligned.
There is likely to be no shortage of sponsors willing to embrace this technology as a balance sheet funding tool, given the number of debt funds that have filled the void left by the banks that have retracted from the real estate lending space.
On the other side of the fence, from an investor perspective, these structures are appealing given the structural benefits vis-à-vis CMBS. Underlying borrowers will also welcome this structure, particularly if it leads to them receiving more favourable economics while at the same time maintaining a relationship with a lender that is able to afford them flexibility on dealing with more challenging transitional assets.
Market participants will also be aware of the challenges linked to the emergence of a new structured product with securitisation at its core. The short-lived life of the European CRE collateralised debt obligation is testament to that as is the rollercoaster ride endured by CMBS over the past 20 years. That said, there are certainly plenty of tailwinds for the CRE CLO including the fact that European CMBS is enjoying a bumper year.
It is therefore the perfect time to herald the emergence of a new structured CRE product. Ultimately, the fundamentals of a CRE CLO make a lot of sense and the fact that this has been developed off the back of a very successful US market and the solid foundations of European CMBS 2.0, means that the European CRE CLO market is primed and ready for growth.
Iain Balkwill is a partner in law firm Reed Smith’s structured finance team, based in London. His practice is predominantly focused on the securitisation of debt secured by commercial real estate