FAP: Bank caution has created mezzanine opportunities in Germany

The Berlin-based advisory and investment firm records 151 investors currently active in Germany’s subordinated debt market.

German banks’ cautious approach to financing real estate during the coronavirus pandemic has created funding opportunities in the country for subordinated debt providers, according to new research compiled by Berlin-based advisory FAP Group.

In its sixth annual FAP Mezzanine Report, the advisory said there are 155 investors currently active in Germany’s mezzanine real estate lending market, nine more than it recorded in 2019, and up from 136 in 2018. It added that the proportion of subordinated capital as part of overall financings has increased on average by more than 13 percent.

“Many subordinated lenders are seeing the reluctance of the banks as an opportunity. They jump into the breach where banks are either not willing to lend or only at low loan-to-value ratios,” said Hanno Kowalski, managing director at FAP Invest, the debt investment business of FAP Group, which operates separately to its advisory business.

FAP said it is witnessing more institutional investors in the mezzanine market, directly and indirectly. It added that, although Asian investors were present at the start of 2020, the covid-19 crisis has led to almost no financing activity from them since March.

It also noted lenders from the US and UK have returned to the market since the onset of covid-19, following a departure in recent years. “Despite their higher returns, they have seen an opportunity to re-establish themselves in the German market,” the report said.

The firm surveyed 53 mezzanine providers for its 2020 report. Between them, they provided €6.9 billion of new mezzanine finance in the 12-month period preceding the survey, 19 percent more than the €5.8 billion reported in the 2019 survey.

The survey sample was comprised of 31 percent loan funds, 29 percent institutional investors including pension funds, 24 percent family offices and 16 percent banks and insurers.

All institutional investors surveyed were financing developments at up to 80 percent loan-to-cost, with around half willing to go to 95 percent LTC. However, only a quarter of those surveyed were willing to waive equity commitments entirely under certain circumstances.

For investment facilities, loan-to-value levels were largely unchanged from 2019. However, it noted that 70 percent of lenders, down from 80 percent in 2019, were willing to accept LTV up to 93 percent – the top end of the range.

For standing properties, most lenders reported mezzanine lending generates returns within a 10-12 percent range, whereas most reported returns within a 9-11 percent range last year. Overall, mezzanine returns vary from 5 percent to 18 percent. For development financing, mezzanine returns were consistent with 2019, with most lenders reporting 10-15 percent.

FAP also noted a trend towards larger-ticket mezzanine loans, with instances of €30 million-plus deals more common than last year, particularly in development financing deals.

The report also found that, despite the growing focus on environmental, social and governance factors across the real estate market, ESG has so far played “almost no role” in mezzanine lending decisions, with lenders making decisions based on traditional industry-standard evaluation criteria.

“Because the term of mezzanine is generally short, the survey respondents usually do not consider the potential longer-term risks that could result from poor marketability of non-ESG compliant properties,” the report said.