Bank’s non-core real estate team believes German market is ripe for disposals, writes Lauren Parr
Royal Bank of Scotland’s unrelenting four-year drive to slash its non-core real estate assets is focused on Germany as 2012 draws to a close.
RBS may be done with selling chunky UK loan portfolios following the Project Isobel disposal, but a dedicated team within the bank is busy assembling granular portfolios of German properties for sale, thought to be worth €300m. Ahead of those sales, it expects to generate nearly €1bn from the sale of the three biggest assets in its German Pegasus portfolio by the end of this year.
All of RBS’s German real estate exposure has been labelled ‘non-core’. At the end of the first half of this year, German assets represented the biggest part of its remaining continental European loan book, which has a nominal value of around £6.25bn.
The bank made the call to offload the flagship Pegasus assets in May. It is now close to completing the sale of Berlin’s Kurfürstendamm Boulevard office tower and Die Welle building in Frankfurt’s central business district to a 50:50 partnership between AXA Real Estate Investment Managers and Norges Bank Investment Management (NBIM).
Taking back the keys to Pegasus
RBS took back the keys to the assets from Morgan Stanley Real Estate Funds in January 2010 and tucked them into its West Register property company, after Pegasus proved one of the MSREF VI fund’s many disastrous investments.
MSREF had paid Union Investment, (formerly Difa), $3bn for the 31-strong, 4.6m sq ft Pegasus portfolio in August 2007 and lost its equity. Of that portfolio, a bunch of smaller assets, including some redevelopments, remain.
A third, retail property from the Pegasus portfolio, the 260,107 sq ft Herold Center near Hamburg, has been sold to Deutsche Euroshop for €187m, in a deal reflecting a 6.1% yield.
When RBS’s non-core division was established in 2009 its first act was to decide which of the bank’s properties were likely to pay back. Since then it has reduced the £63bn of non-core property assets by £38bn, with loan run-offs being the largest single component of that reduction.
That wasn’t the case in Germany, however, although RBS has taken part in refinancings by allowing good companies with good real estate the time to get a new syndicate in place – Valad’s refinancing of the European High Income Fund is one example. But by and large, it is starting to exit its German assets one by one.
The German portfolio is made up of a small amount of multi-family apartments, but the bulk of it is office buildings said by insiders to be in ‘sensible’ locations across western Germany, such as Düsseldorf and Frankfurt.
The right time to sell in Germany
The bank’s non-core team believes it is a good time to start shedding German assets, partly because yields have fallen, mainly due to interest rates being so low. Also, with quantitative easing having slashed corporate bond yields, real-money investors such as US fund managers and sovereign wealth funds are desperately short of products to invest in – hence AXA’s expansion and NBIM’s diversification into property.
At one point, RBS had toyed with the idea of reducing its German property exposure by packaging up a large loan portfolio, as it had done in the UK with Project Isobel. However, Project Nina – one of a string of actual and potential deals named after the children of the non-core division’s employees ailed to take off.
The non-core team decided not to go ahead with Project Nina because it estimated that the potential proceeds would have been 25% less than it would gain by selling the underlying assets. The conclusion was that Germany is not a single market, but lots of smaller ones, and RBS’s exposure there is more granular.
The group’s general strategy has been to sell real estate rather than loans, because it can produce better returns for shareholders that way – a factor that is more important than ever in the face of criticism of the bank’s poor share price performance.
Coming out of the Asset Protection Scheme in October may have saved RBS £500m per year in insurance payments to the government, but its focus has not altered. Last month, BBC’s business editor Robert Peston pointed out that the RBS share price, then at 282p, was still 44% below the price paid by the Treasury on behalf of UK taxpayers (though it has since briefly touched 300p).
Peston noted: “The paper loss is therefore a painful £20bn. What goes down can bounce up again – but not for long or with much effect, if the falling body is the fabled dead cat.”
A recent exception to the assets-not-loan-sales strategy was RBS’s sale of an Irish loan securing State Street bank’s Dublin headquarters. Kennedy Wilson pipped Delancey and KKR to the post after both parties offered the same price and were in a straight contract race.
RBS only agreed to sell the debt on the asset, rather than the property itself, during the process because it was offered the same price as for the real estate – and for the bank, selling the loan was clearly the easiest option.
RBS ‘took its medicine’ in Spain
In the past month it has also sold a Spanish position it held in a syndicate. The bank mainly sold out of Spain in 2010, deciding to ‘take its medicine’ on its Spanish property exposure early in the non-core run down process, in what sources say turned out to be a good decision.
It sold all its smaller Spanish secondary loans and exited almost €1bn of exposure in total. The only remaining property exposure in the country now is residual.
The rate of reduction of the real estate non-core book is in fact less impressive than the inroads made into the overall non-core loan book – a 60% fall in the mountain of non-core property, compared to a 75% fall in total non-core.
However, whether by luck or judgment, investor appetite for German assets this year means that the non-core real estate team will have boosted the £6.5bn of real estate deleveraging achieved by Q3 2012 to a higher figure by the end of the year.
Non-core property disposals in Germany will continue to be a priority for RBS next year, but reducing its real estate exposure in Ireland will be the really big challenge. Perhaps the bank’s timing will turn out to be fortuitous there as well.
Four-year sales campaign has scratched £38bn from RBS property loan book
At the end of the third quarter of this year, the value of RBS’s outstanding non-core loan book stood at £65bn, with commercial real estate accounting for £25bn (see chart below).
Of that £25bn, £6.2bn of loans were in Ireland, about £3bn related to small loans and £15bn came under bigger loans on European assets, including the UK and the Pegasus portfolio in Germany.
The bank’s original loan book spanned the UK, Germany, Spain, France and to a lesser extent Italy and the Nordics. Typically the bank made bigger loans on core, grade- A property, but also a series of smaller loans on smaller assets.
The secondary property is more granular, predominantly in the UK and Ireland, and in Germany.
To get to £25bn at Q3 2012, the non-core property book has been reduced by £38bn in nearly four years, from almost £63bn at the end of 2008.
However, the non-core loan book for all assets has been slashed back proportionally faster: from £258bn in 2008 to £65bn at Q3 2012. At one time, the bank had talked of exiting all its non-core portfolio by the end of next year; its Q3 2012 results more recently stated that it “remains on target to exit around 85% of the original portfolio by the end of 2013”.
The combined core and non-core property loan book was £70bn at the end of Q3, which included almost £40bn of core commercial real estate lending.