Market volatility is forcing borrowers and lenders to think carefully about how they approach the rest of this year, writes Real Estate Capital editor Andy Thomson in his second report from Frankfurt.
“We lent €2.2 billion last year, which represented a great year for us,” reflected John Barakat, head of real estate finance at M&G Investments, in a keynote interview at the REC Germany Forum 2016 in February. “That may not compare with certain banks doing around €9 billion but it was terrific for us and we didn’t predict it at the beginning of the year.”
That was the good news. Looking ahead, Barakat’s tone became more cautionary. “Twelve months from now, we will definitely look back and say 2015 was a great year as now there are headwinds. We’re in a really volatile market right now, even though in this room it may not have been felt that much yet. There is a macro overlay that we have to bring to bear on our decision making.”
He added: “I think we will see some European markets tread water this year and some will decline. Some places will be fine, but everywhere stock selection will be crucial.”
If taking something of a step back is what’s required, it’s not something Barakat appeared unduly worried about. “We don’t think too much about targets,” he said of his own team’s approach. “We are stewards of third-party investor capital. If you want longevity in the market you have to be willing to say that you will do a little less this year.”
‘Different part of risk spectrum’
Faced with a weight of capital, pricing pressure and yield compression, Barakat said “it feels like you’re in a different part of the risk spectrum. But real estate is still providing decent relative returns amid such low interest rates.”
Speaking specifically of the German market, he said: “It’s very tough to compete, with very experienced lenders who often have a different funding cost and they do what they do very well. But we have sometimes provided junior behind German bank senior and sometimes participated alongside German lenders, as well as providing mezzanine top-ups.”
In concluding remarks, he said: “Insurance companies will increase their market share by some measure. There are some debt funds that have been very successful but I don’t think we’ll be seeing too many more new entrants. Most of them have not been through a cycle yet with the need to do work-outs and preserve capital.”
In a panel on the financing markets, entitled “Fierce competition, low margins and strategies for finding value”, Frank Jeschke, head of portfolio management CREF at LBBW, reinforced the view that tough conditions demand a clear strategic focus.
‘Time for mistakes’
“We have always had a very conservative lending policy in recent years and we are not ready to change that, even when we see increasing demand for aggressive value-add and high LTVs,” said Jeschke. “We think now is the time for mistakes to be made on the lending side if too many risks are taken. We found a lot of business we liked in 2015 but if the quality is not there in 2016 then we’ll do less.”
“We [the market] are below reasonable margins right now,” added Jeschke. “We will see some changes in the lending market and it will be challenging but interesting. When will the changes come? We are not seeing it yet but we have to consider it now and we have to price things cleverly.”
“Banks are forced to try and increase margins, otherwise they will have severe problems,” noted Raimund Fruhmorgen, a managing director at UniCredit Bank. “It’s not healthy to do something at 80 basis points. You have to try and increase the margin or things could begin to look bad after a matter of months.”
On a panel focused on the borrower perspective, Roberto Carrera, head of European debt financing at LaSalle Investment Management, said: “We are continuing to see very fierce competition in German lending and also in France, where pricing is getting closer to Germany – especially for prime.”
Debt advisers: the future?
The panel went on to consider the possible role of debt advisers given an increasing diversity of financing choices. “We’ve not used debt brokers but we might in future,” conceded Hugh Fraser, head of capital markets at M7 Real Estate. “There are markets where we’re not familiar with the local geography and it’s clear that there is an important role for debt advisers if you look at a firm like Eastdil.”
“We have good relationships with a core of 15 to 20 banks,” said Barkha Mehmedagic, executive director and head of asset financing & group treasury at Commerz Real. “We try to build a deep understanding of their mechanisms and products so we don’t run to 15 banks each time to get a quote. We typically don’t work with debt advisers but we do see more of them coming into Germany.”
In a presentation on the German CRE market outlook, Gunnar Herm, head of real estate research and strategy for Europe at UBS Real Estate, predicted that Germany would under-perform the European average on a returns basis going forward, while Spain would be a top performer.
“Those [countries] which have suffered most will benefit more,” he said. “There is more downside risk in Germany and upside risk in Southern Europe. Safe havens and gateways have less upside potential.”
He also forecast that, while the offices sector would under-perform relative to other European markets, the retail sector in Germany was “less volatile” than elsewhere. Additionally, he highlighted the big cities – a magnet for the young in particular – as growing “much faster” than the rest of the country.
In the concluding panel, exploring investor confidence in Germany, Marie-Antoinette Kuhnle, vice president at Landesbank Baden-Württemberg, said that bankers are “in a difficult situation where you have to make profits but there’s high regulation and costs and we like to restrict the risks. It’s quite a challenge”.
However, she added: “At the moment, investors are still quite interested and actively investing in real estate. Yields are low but low-yielding real estate is still better than very low or negative interest rates.”
* This is the second part of our report on the REC Germany Forum 2016. You can find the first part in our March 2016 issue, or go online to www.recapitalnews.com.