The UK real estate industry is moving back to the future. In five to 10 years’ time, insurance firms will be significant debt providers; banks will play a smaller role in financing real estate; there will be more funding via the capital markets – CMBS, bonds, debentures; and indirect equity investment via unlisted funds is likely to languish.
Some of these trends are highlighted in the recent Lending Intentions Survey from Investment Property Forum and the Association of Property Bankers. I should declare an interest – I wrote it. I spoke with most major UK lenders: insurers and banks. One clear message was that regulation will transform the landscape. “The biggest risk to business is regulation around the globe; conflicting or contradictory regulations, or the implications of legislation in different countries,” said one banker.
Banks are already factoring in Basel III capital charges that promote more conserva-tive lending, and less of it. Moreover, if adopted, the Vickers report’s proposal that UK retail banks hold a thicker capital cushion will add more pressure. For insurers, Solvency II looks like encouraging European institutions towards real estate debt, perhaps at the expense of providing equity.
This would create a market similar to that of the UK in the 1970s. Then, banks provided property companies with operating facilities and short-term bridging loans; investment assets were financed with long-term mortgages from insurers, bonds, mortgages or mortgage debentures. Leveraged, unlisted real estate funds did not exist.
These themes surfaced at the annual conference of unlisted property funds body INREV this month, where European fund managers heard INREV’s research into the downturn’s legacy conclude that, in the medium term, less equity capital will go into European non-listed real estate funds. Fixed-income products are more appealing, as are other economies. There is more competition for capital.
One unintended consequence of regulation is that the middle ground may be squeezed. Basel III and Solvency II capital charges favour low-risk, core assets; if a bank or insurer is going to incur a high capital charge, they will do so sparingly, on high-risk, high-return, opportunistic strategies. For investments, this means that value-added assets and funds will lose ground.
Fund managers also face regime change in the shape of the EU Alternative Investment Fund Managers directive, due to go live in April 2013. As well as capital requirements, it also aims for better risk management and reporting.
As a journalist, I hear plenty of anecdotal evidence on how bad some banks’ documentation has been, on underlying assets as well as loans. This is also like the early 1970s UK investment market, before Investment Property Databank was set up, when institutions hoarded portfolio data and property consultants produced competing indices, so performance measurement was primitive.
Today, IPD’s monitoring of institutional investment provides a very good fix on this market, as well as performance indices and benchmarks. Investors in unlisted funds have INREV’s index, and will further benefit from the AIFM directive.
There is no equivalent in the debt sphere. Real estate debt could bring down the financial system, yet not even the Bank of England knows much about it beyond headline figures on outstanding property loans. When it comes to a breakdown of residential to commercial, investment to develop-ment, or loan-to-value ratios, our only insight into £215bn of real estate lending is thanks to the annual lending report of lone academics Bill Maxted and Trudi Porter at De Montfort University.
It makes sense for banks to outsource data and loanbook analysis to IPD-style independent third parties. Insurers and pension funds got comfortable with the security issues involved, so why can’t banks? It would be sensible to spread the costs involved by developing a common platform and an industry standard. In the US there seems to be a move towards third-party service providers like Trepp, so why not something similar in the UK?