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First Growth Real Estate: Plugging the gap in Europe

First Growth co-founder Cyril de Romance identifies gaps in Europe’s property lending market – and tells Real Estate Capital how the advisory firm is uniquely positioned to help clients fill them.

This article is sponsored by First Growth Real Estate

Property debt capital sourcing is becoming more complex, with a myriad of new providers that continuously change targeted exposure and lending strategy. In addition, borrowers encounter gaps in the market for a variety of loans. For instance, it’s challenging to secure debt in the mid-single-digit pricing range beyond plain-vanilla transactions. There is also less debt liquidity for small-ticket or highly leveraged deals. The same goes for covid-challenged sectors or certain development projects.

Throughout the pandemic, First Growth has sourced and arranged over €2 billion of debt across more than 20 transactions in France, Italy and Spain. Co-founder Cyril de Romance explains how the advisory firm is constantly finding creative ways to plug the gaps across Europe’s lending market.

Lenders are mostly focused on the extremes: banks, conservative debt funds or insurers typically provide debt at sub-3 percent; and more expensive debt funds at 8 percent. Where can borrowers source debt in the middle of that price range?

Cyril de Romance

In the current environment, you can either meet the tight criteria of the traditional senior lenders – and therefore access competitively priced financing – or clients must turn to more expensive debt from less competitively priced debt, special situations or private equity funds, whose cost of capital can quickly hike.

Cheaper financing, therefore, is getting more difficult to source. Banks are currently focusing on stabilising their books and supporting their existing clients rather than underwriting new risks. In addition, the market has been experiencing a ‘flight-to-quality’ phenomenon, where cheaper financiers tend to lend against core assets in established locations and pay particular attention to the sponsor’s and operator’s track records.

On the other hand, debt funds or insurers have raised record amounts of money in the last year and are ready to deploy to take advantage of the withdrawal of the banks. They are bringing liquidity to the market, but there are very few who can be competitive with bank lending costs.

Debt funds create great value when they can provide a fast, efficient and not-too-expensive solution for investors who are in urgent need of funding capital. But the majority of funds who are ready to deploy with quick and efficient solutions have expensive capital costs, starting from 7-8 percent. Meanwhile, funds whose cost of capital is on the cheaper side are very cautious on where to allocate their liquidity.

We have sourced and arranged financings with lenders able to deploy at mid-single-digit returns, delivering tailored solutions to clients’ needs. This required us to constantly scout the market for those sort of debt providers and seek to create pools of lenders with different costs of capital deriving from varied loan characteristics – as in the LBO model, which is less the case in real estate.

For instance, we sourced a four-year circa €35 million loan from a London-based debt fund at 5 percent to refinance the acquisition and finance capex works for a residential portfolio in Madrid. This space, however, is where we feel there is less market liquidity, which is also an opportunity for new debt funds. For a high-end residential development on the Croisette in Cannes we sourced financing from a Middle Eastern lender who wanted to be exposed to that market.

Smaller deals have more difficulty attracting debt from bigger institutional lenders. Who is financing the small-ticket loan market?

Higher liquidity falls in the €50 million to €100 million loan size band for institutional lenders. Below this amount, you have to deal mainly with local bank lenders. The business of these banks is typically more focused on enlarging their clientele rather than providing one-off financings. They can therefore be attracted to building new relationships with clients who can bring value to the bank, not only through real estate investments but also through private banking business.

With liquidity drying up in 2020 – especially for certain asset classes such as retail and hospitality – local lenders have, in numerous instances, filled the gap left by national and international investment banks.

In France, we sourced financings by local lenders one by one for a total of seven serviced office assets for a client building up a portfolio of such assets in regional cities. Local lenders are fully knowledgeable about their relevant regional market and are perfectly suited for arranging financings in cities where investment banks do not have their

How can borrowers source larger tickets from local lenders?

As local lenders are limited to the €15 million to €20 million ticket size, we have structured several transactions by pooling them to achieve significant size financings for portfolio transactions, or a large single-asset deal. It is more and more common to create lender pools by mixing different types of lenders, such as local banks and debt funds.

In June 2021, we mixed a bank and a debt fund to close a €45 million high-street retail portfolio refinancing in Rome and Milan owned by the UK-based family office Trophaeum.

Local lenders are playing a key role as they can arrange the financing for debt funds who are less knowledgeable in jurisdictions where the degree of complexity of arranging debt is higher.

Since institutional investors typically have no connections with local lenders, and are not used to working with them, our services have been instrumental in connecting them, assisting lenders in constituting pools and managing the heavy lifting and time-consuming processes needed to get deals over the line. This brings immense value to our clients.

In December 2020, for instance, during the covid lockdown when ski resorts were closed, one debt fund lender pulled out of a deal to refinance the acquisition of a portfolio of eight boutique hotels located in the French Alps owned by the private equity fund KSL. We nevertheless were able to source and arrange a €50 million refinancing loan with a pool of four local lenders at competitive pricing.

Which sectors are currently experiencing a lack of debt liquidity?

Following the outbreak of the covid-19 pandemic, financing of operational assets across Europe became more difficult, since properties such as shopping centres and hotels were forced to close. The hotel and retail real estate markets are getting more active, but there isn’t full visibility yet as to when these assets will return to pre-pandemic performance levels.

Investors are currently looking to seize opportunities in these markets with optimism. They are looking beyond the immediate impact of covid on these sectors and looking at hospitality and retail as strategic long-term investments. There’s a consensus that now is the right time to invest before these markets recover and the discount opportunities disappear.

Europe’s retail and tourism markets are reopening and liquidity against retail and hotel assets is coming back, whether it is for distressed, refinancings, recapitalisations or acquisition financings. However, traditional German lenders and debt funds remain extremely cautious with asset classes like hotel and retail, especially non-food retail.

For hotels, lenders prefer to back large city centre or branded hotels and leisure resorts. For high street retail, the luxury market is now reviving thanks to the expectation of a more stabilised social situation, travel and movement in the short term. In addition, grocery and food retail has demonstrated resilience during the covid crisis, as the sector is indispensable and has remained operational throughout the pandemic.

In Q4 2020, we closed two iconic hotel refinancings – the five-star Park Hyatt Hotel located in the historical centre of Milan and the portfolio of eight boutique hotels located in the French Alps, which I mentioned before. We are telling our clients to grasp the liquidity as it becomes available for these kinds of assets.

We are currently seeing possibilities for borrowers to refinance with some equity cash out – especially for logistics or residential assets – assuming, however, that some level of equity stays in the deal.

Most lenders operate in the senior debt space and, with covid, leverage has been adjusted downward. Is it harder now to source highly leveraged debt?

Over the last year-and-a-half, we have seen loan-to-value levels going down as a result of a de-risking strategy by banks. In logistics and residential, however, you can still achieve 65 percent LTV at very competitive cost-of-capital levels. Usually, this LTV level is achievable as soon as an occupancy of 80-90 percent is reached.

In other asset classes, there is still no clear view of the market. We have seen, though, that a 55 percent LTV is the cap for many lenders in the hospitality and retail market. To remain competitive in terms of pricing, a lower LTV is often required by lenders, as well as collateral to service the debt for shorter or longer periods of downtime.

Which development projects are experiencing an undersupply of debt finance at the moment?

Given the higher degree of complexity and uncertainty of development transactions, not all lenders are able to consider development financing.

There is no market consensus on development financing, especially for hospitality, where some lenders see development as ideal to opening well post-covid, while for others it just adds risk to the transaction.

Most bank lenders put development financing on hold after the outbreak of the pandemic and do not yet have visibility on when they will be able to come back to deploying capital against development projects. Debt funds, instead, see development projects as a big opportunity to increase their returns during these times, and are considering more and more development financing.

Nevertheless, timeline, planning, construction milestones, creditworthiness of the sponsor and track-record of the general contractor are of paramount importance in lenders’ valuation and analysis of the financing opportunity.

The more information you can provide to lenders, the more likely they are to be interested in a transaction. We are currently working on various development financings for logistics assets, hotels and purpose-built student accommodation.

Lightbuld jigsaw puzzle ideaWhat kind of solutions are your clients asking of you as they seek to fill gaps in the debt market?

Finding creative ways to fill such gaps is our job, and this is how we bring value to our clients. First, we are very close and fully aligned with our clients, and we increase their certainty of execution by pointing them towards the most appropriate lenders. It is also about helping borrowers devise their business plan and projected cashflows, advising on suitable ownership structures to enable them to attract the appropriate financing and bringing down loan pricing by creating competitive pressure.

We then study every financing possibility as a potential option so we can find the best way to structure, tranche and pool a deal. Frequently, a client will come to us with a specific set-up in mind, and we end up structuring the operation differently, because it works better from a lender’s perspective. Considering different ways of structuring also allows us to expand the universe of lenders and unlock cheap financing, especially in this context.