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Why German real estate bankers are under pressure

Lenders are busy in the country’s booming property market, but fierce competition, high property prices and tightening regulation are challenges they face.

Asked if German banks’ appetite for commercial real estate lending is waning, given origination volumes dipped in 2017, one lender, speaking in private, switches to the subject of his beloved Bayern Munich football club to make a point.

“A few years ago, we had Pep Guardiola as our manager and we were winning games four, five-nil,” he fondly remembers. “Then, we got Carlo Ancelotti. We were winning two, three-nil, but we were still winning.”

“We’re in a very comfortable position,” he continues, returning to real estate lending, “and for a market operating at such a high level, small changes are not a worry.”

Investment in German real estate remains high. In the first half of 2018, €26.1 billion was recorded by BNP Paribas Real Estate, a slight increase on the same period in 2017. Full-year investment in 2017, at more than €58 billion, was the second-highest recorded by the consultancy, 2 percent short of 2007 levels.

However, the latest German Debt Report, published in June by the International Real Estate Business School at Bavaria’s University of Regensburg – the most comprehensive survey of the country’s property lending community – shows lenders’ new business volumes across its €185 billion sample dipped for the first time since the analysis was launched in 2010. The decline was not severe – from €106 billion in 2016 to just under €100 billion – but it hints at the headwinds bankers are facing.

A reduction in loan-to-value ratios across the market, as well as increased market share being won by smaller banks – underrepresented in the survey – are the most likely explanations, suggests the report’s co-author, Markus Hesse. However, he argues banks remain as keen as ever to do business: “The appetite is huge, otherwise the levels of competition in the market couldn’t be explained. If the overall cake becomes smaller, but the appetite to get a slice of that cake remains, it becomes trickier to do business.”

Germany’s banks put in a mixed performance in 2017, by volumes. Helaba’s origination dropped from €10.4 billion in 2016 to €8.7 billion in 2017, with Aareal’s down from €9.2 billion to €8.8 billion. Meanwhile, pbb Deutsche Pfandbriefbank achieved a record €10.7 billion last year. Overall, Pfandbrief banks remain some of Europe’s largest real estate lenders.

The banks’ continued exuberance for property lending remains warranted, even at this advanced stage of the real estate cycle, argues Christian Schmid, executive vice president at Helaba: “The driver of the market and the increased value of property is the German economy, which is very, very strong,” he says.

The uncertainty created by Germany’s recent political deadlock and eurozone issues such as Brexit, has done little to hinder the economic performance, with 2.5 percent growth in 2017. Germany’s bankers are not prepared to give up real estate market share but maintaining profitable loan portfolios in such a competitive environment puts them under extra pressure.


Competition among Pfandbrief banks remains intense, while Germany’s network of savings banks (sparkassen) and co-operative banks (volksbanken) are also growing their exposure to property debt. Financing through the capital markets is also an option for borrowers, with listed firms including Aroundtown sourcing debt from outside the banking market.

Increased levels of loan repayments are also a source of pressure. Given consistently large lending volumes over the past several years, it is difficult to identify a spike in repayments, with some banks having experienced a peak between 2015 and 2017.

Loan pricing has dropped for five consecutive years, with net margins across the German Debt Report’s sample down to an average 104 basis points, from 106bps last year and 134bps in 2013. “We are still getting closer to the bottom; we are not really on the up,” the report stated.

‘Micro-margins’ on core business remain within a range of 50bps to 70bps, on conservatively leveraged loans, below 60 percent loan-to-value. Despite the tight pricing, banks need to pursue such business to maintain the volume of vanilla property assets across their portfolios.

There is higher-priced business out there, explains Markus Kreuter, head of real estate finance and private equity at Luxembourg-based private equity boutique SIMRES, which advises clients in the real estate sector. “Lenders can get pricing above 100bps for core-plus, outside prime locations, or where there is a need for fit-out or there is a short lease term,” he explains.

Aligning risk across loan portfolios to protect profitability is a challenge for bankers. Even when travelling up the risk curve, banks are not being sufficiently compensated for taking on more risk, according to the German Debt Report. Hesse recalls conversations with lenders while compiling the report earlier this year. “During interviews, bankers were talking about low-priced core-market business on the one hand and running up the risk curve on the other. I began to wonder, what about the middle ground?”

By middle-ground, Hesse is referring to medium-sized, medium-risk deals, carrying medium margins; neither shiny core property, nor risky assets in need of asset management. The conclusion he reached is such business is being done, but it is being perceived – and priced – closer to traditional core, with even development seen as ‘future core’ by many.

“Everything you could consider core or core-plus was under strong margin pressure. And even if the deal was just OK, it was still under the sort of pricing pressure you might expect from core business,” explains Hesse.

With the ‘in-the-middle’ business increasingly looking – and paying – like core lending, bankers are increasingly offsetting it with value-add, opportunistic or construction loans. “Some investors of developments and value-add with high capex needs as well as opportunistic investors are still looking for leverage to keep headroom for doing additional deals and keeping the returns up. Here, banks should keep a very close eye on the risk profile with sufficient covenants and better pricing – and sometimes a ‘no’ might be the right answer,” says Hesse.

Development and value-add business plays a role in Schmid’s outlook, but needs to be carefully managed, he adds: “We do not want to increase too much the percentage of our portfolio which is development, but we do have room for manoeuvre. Across German banking, I do not have the impression there is anyone who is prepared to go too far up the risk curve. Most of my colleagues have the last cycle in mind and are aware we are far into this cycle.”


High capital values for Germany’s prime property are a concern, some argue. “We are heading to the end of a cycle, so the question is, how much risk is in the valuation?” comments SIMRES’s Kreuter.

“A loan written 10 years ago at 70 percent LTV would reflect 40 percent at today’s prices, but a loan written today at 68 percent will not reflect that level five years from now,” he continues. “Another issue is some banks are lending to development projects at loan-to-cost ratios of 90 percent in cases. Even with the value created on the completed property, the LTV of the eventual stabilised loan will be higher than the day-one LTV a lender would be prepared to originate in an investment financing deal.”

The German Debt Report showed average LTV shrank in 2017, from 64.6 percent in 2016 to 60.9 percent. However, compared with 2013’s property prices, adjusted LTV looks more like 80 percent. Credit risk looks manageable, the report said, but the amount of headroom in loan deals is reducing.
Leverage is also a factor Helaba’s Schmid is closely monitoring: “The longer we are into the cycle, of course there is less headroom. But the fundamental basis for the German market is strong and headroom is not shrinking dramatically, so banks don’t need to be too concerned.”

Hesse explains leverage remains largely in check. If property values were to fall to 2015 levels, leverage would be north of 70 percent, but lenders’ positions would still be covered. Under several test scenarios, he adds, debt service coverage ratios were also found to be covered. The real issue for bankers, he argues, is that a downward adjustment in values might create a regulatory issue under Basel IV for banks, with greater volumes of equity required to be set aside to counter higher-LTV lending, hitting profits on already thin margins.

“Core, financed at micro-margins, only makes sense if it is backed with a lot of equity,” says Hesse. “The market is therefore discussing the merits of core versus taking a little more risk. While core lending is sensible from a recovery point of view, the new regulation framework requires an uplift in equity if core business comes under price pressure.”

Ensuring lending business remains profitable against a backdrop of increasing regulation is a challenge, Schmid agrees: “There are elements in my cost calculation that will increase, such as the Basel IV output floor, so it will shrink my net margin and I need to consider how to turn it around.”

Another area in which competitive pressure is becoming apparent is deal structuring, with some banks reportedly relaxing certain loan covenants to win business. “Most banks stick to interest cover ratio covenants, as they need to get a handle on the rental income if something goes wrong,” explains Schmid, “but some of them, for example, relax the LTV covenants so the trigger is closer to the level of leverage where the lender needs to be in a position to do something.”


The 2008 financial crisis exposed the overexuberance of several German banks in real estate, both within Germany and abroad, leading to state bailouts for some. Those lending today argue their business remains conservative in an equity-driven market. But should Pfandbrief bank boards be considering reducing property exposure in the next few years, given the increasing possibility the current cycle is reaching its conclusion?

“It’s difficult to answer,” admits Helaba’s Schmid, “we are always aiming to stabilise the income situation, but our equity situation is so strong we are able to do more business. We have decided we want to slightly increase the overall balance of our property lending, but we don’t believe there is room to be aggressive in the market. In Germany, we want to stay stabilised and not lose market share.”

SIMRES’s Kreuter notes the return of some investor behaviour akin to the top of the last cycle, but he believes banks will not take on undue risk. “We already see some of the crazy guys back in the market, some buying property three months ago and expecting to sell it on already as if it was 2007 reloaded,” explains Kreuter, “the banks know they can’t do that. They have enough to live from and show good returns on their balance sheets. They’re not desperate.”

While Schmid says there will be a time when property lending becomes more challenging as the cycle turns, he argues that is not the situation now, with current lending taking place within parameters that are unlikely to create future problems. “The headroom is such that there is no need to sound an early warning,” he says, “and we don’t see anyone putting the brakes on just yet.”