As German banks have reduced the loan-to-values they are willing to provide against real estate in their domestic market, an opportunity has arisen for mezzanine debt providers to write loans against good-quality developments and existing properties in Germany from sponsors that had not been tapping this market before. That is the argument put forward by Hanno Kowalski, managing partner at Berlin-based debt fund manager FAP Invest, which secured an additional €50 million of investor capital for its subordinate lending strategy in June.
According to Kowalski, several German banks have reduced their typical LTV from 70 percent to close to 50 percent during the pandemic, with a stronger focus on core and ‘trophy’ assets. “Banks in the country are leaving increasingly bigger gaps between senior debt and hard equity,” he told Real Estate Capital.
Therefore, as quality sponsors require additional finance to make up for the shortfall from banks, mezzanine lenders are being presented with opportunities to provide junior loans against core assets and “solid development projects” – less risky deals than would have been available to them pre-pandemic, he argued. This, Kowalski added, means what he called the German “core mezzanine” debt market is increasingly attractive to institutional investors.
“If well-established borrowers go into that market, that changes the risk profile of those deals. In the past, similar types of projects would have often been fully leveraged,” he explained. “There are now lower-risk mezz opportunities in the country, which institutional investors, excluding the classic private equity firms that look for double-digit returns and high-end risk, are finding very attractive. They see it as solid lending, but less risky than traditional subordinated debt.”
Kowalski added that, from an investor perspective, this market in Germany is considered an alternative to other fixed income products since it offers attractive risk-adjusted returns “without exposing them to the typical mezz type risk”. He said: “For investors looking for returns of 6 to 7 percent, rather than double-digit returns, Germany’s ‘core mezzanine’ is a great investment opportunity.”
Kowalski explained that although tougher banking regulation is the main reason banks have become more cautious in their real estate lending, the pandemic has intensified their reticence. “The pandemic was not the cause but has made it happen more quickly.”
FAP Invest announced on 25 June it had raised more than €200 million for its mezzanine debt fund after securing its largest individual investor commitment – a €50 million contribution by a German insurer.
Following this commitment, the firm is confident it will secure another capital inflow of around €50 million during the third quarter of the year, Kowalski said. “We have investors in the due diligence process to provide the remaining €50 million. We expect that from three to five German investors will come onboard with ticket sizes between €5 million to €15 million.”
The German lender plans to hold the fund’s final close at the end of December at its target size of €250 million. While the pandemic has not led FAP to reduce the vehicle’s target size, it has slightly delayed the fundraising process. “We had planned to hold the fund’s final close at the end of June, but covid-19 has made fundraising conversations with existing and new investors tougher and slower, due to barriers to in-person meetings.”
The firm launched FAP Balanced Real Estate Financing I Fund at the end of 2018 with the aim of allocating subordinated capital to existing properties, redevelopment projects and developments in Germany. Since Q4 2020, the firm has deployed, through the fund, more than €80 million in a variety of mezzanine deals including the revamp of Düsseldorf’s Königsallee high street and the development of a plot in Frankfurt.