Sourcing debt for multi-let real estate in regional locations across Europe is not always straightforward, admits Hugh Fraser, head of capital markets for M7 Real Estate, which specialises in it.
Real Estate Capital: What role does debt play for your business?
Hugh Fraser: We always need to be sure the debt tail does not wag the dog. If property values fall, we do not want lenders telling us to change our business plan. So, we do not push leverage beyond 65 percent and that capital costs between 100 basis points and 350bps, depending on where you are in Europe. It must be accretive to our equity returns, typically a distributable 8-9 percent. But debt costs would need to rise above 500bps before they stopped being accretive.
REC: How do you structure your financing deals?
HF: Typically, we will use senior debt up to 60 percent of the capital stack, with a fixed income loan note accounting for 60-80 percent. For that, we register a bond which pays a high coupon, because it is tax-efficient, but also because our investors like to put capital into debt instruments as well as our equity funds. The 80-100 percent part of the stack is funded through equity.
REC: What do you look for from a lender?
HF: They need to get our sector and the granularity of the assets we buy. Lots of people don’t like grubby regional real estate – we love it. We hate locking cash in an account to make the lender feel comfortable it will be spent on capex. We have so much surplus cash in our vehicles that we ask lenders to be flexible on how we fund our capex programme. Also, loan-to-value covenants need to provide some breathing space; in a loan with 60 percent LTV, I wouldn’t want to see a cash sweep set anywhere lower than 72.5 percent, for instance.
REC: Are covenants shifting in borrowers’ favour?
HF: Maybe for the biggest players like Blackstone, but I do not see a relaxing of covenants in M7 facilities. We do not push for light covenants, because covenants at the right level can create good discipline. I certainly don’t see a shift towards covenant-light.
REC: What could lenders do better?
HF: Many banks could be more transparent upfront about what they can and cannot finance, rather than waiting until they issue indicative terms. A lot of banks are still poor about being open and honest about what they can do, because they want to maintain the pretence that they are open to all types of financing when they are not.
REC: Where is pricing in your part of the market?
HF: It varies significantly by country. In Denmark, we are borrowing at 55 percent LTV and paying 80-100bps, because lending is funded through the efficient Danish bond market. In our biggest markets, Germany and the Netherlands, pricing from the investment banks for the type of product we buy has not changed dramatically in five years; it is in the region of 325bps, while the UK is between 250bps and 300bps.
REC: Is Europe a liquid debt market?
HF: In some countries, the terms you get can depend on the day of the week you turn up. Debt for our sector cannot be described as a liquid market. Prime, core real estate is entirely different.
For regional real estate, it is usually possible to source finance, but it is not truly liquid if it comes from the same few lenders.