In a competitive market, borrowers value speedy execution and sound covenants as much as low pricing and high leverage, debate at CREFC Europe’s event proved. Jane Roberts reports
Nine borrowers and lenders debating what borrowers “really want” was the centrepiece of CREFC Europe’s conference in London on 9-10 November.
The discussion, chaired by Omni Capital chief investment officer Dan Smith, also had an eye on the market cycle, bearing in mind the conference’s title: ‘FrothyTimes?’
Some clear answers emerged: borrowers put more weight on flexibility and sound covenants than leverage and pricing; they value speed and certainty of execution in a very competitive investment market; and above all, they want a close relationship with lenders that understand their business, not commoditised debt.
The lenders claimed this is exactly what they want too. Debt fund lenders Rob Clayton of DRC Capital, Andrew Radkiewicz of Pramerica Real Estate Investors and Daniel Pottorff of LaSalle Investment Management, reported repeat business with borrowers, as high as 50% of deals.
But the panel was divided on whether close borrower-lender relationships precluded a role for the growing number of advisers broking debt deals in Europe.
Two borrowers, Colin Throssell, fund managerTH Real Estate’s head of treasury, and Richard Croft, chief executive at value-added investor M7 Real Estate, gave brokers short shrift. “It very much depends on where in the capital stack you’re looking to borrow,” Throssell argued.
“For a core borrower like us, typically at around 55% LTV, a broker doesn’t offer a great deal more in terms of sharpening price… It is a fragmented market and you could beat yourself up looking for an extra couple of basis points on your margin by going to 60-65 lenders. But if you accept sensible pricing and go down the relationship route I don’t think brokers offer a lot.”
Croft’s point was that understanding debt liquidity was a central part of an investor’s role: “You’ve got to make it your job to find out exactly who is in the market, the same as you find out who’s in the market to acquire the kind of assets we’re trying to buy, or to sell what we’re trying to buy.
“Debt is just another commodity that occasionally has this mystique about it, that it’s a bit complicated. It isn’t; it’s just another part of the capital stack.We try and find out who the equity sources are; we try and find out exactly who we should be trading with in terms of buying assets; and it is exactly the same with debt.”
The lenders were kinder. Roman Kogan, European commercial real estate head at Deutsche Bank, said advisers were most useful for borrowers “who don’t have financing staff ”.
LaSalle IM director Pottorff said: “The deals we look at are by their nature more complex. Not only is it higher-leverage, sometimes it’s a complex asset story… that maybe a traditional bank doesn’t want to approach. I think a broker can help with complexity – it’s not just about setting up the competitive tension.”
One borrower on the brokers’ side, Catherine Webster, a director at Lone Star’s in-house asset manager Hudson Advisors, said: “Our smallest deal is about £250m; our loans are huge. So if we’re asking for a bank to underwrite, they want the security that the syndication market is there.”
A broker can help that process, identifying secondary as well as primary lenders, she added. “It provides huge comfort to get that level of debt underwritten and secure.We see them as helping lenders help us.”
Speed and certainty are key
The importance of certainty and speed of execution is key for many borrowers, agreed Tristan Capital Partners’ Ali Otmar. Several borrowers said few sellers will accept a financing contingency when more often than not it’s a seller’s market.
DRC and Pramerica debt fund managers Clayton and Radkiewicz had provided certainty for investors by underwriting whole loans, if at a premium.
Radkiewicz said that if someone has a very short time to close a deal “and it could involve senior, mezzanine, even a tranche of preferred equity, then certainty and ability to complete is not counted in basis points.
“Perhaps it’s a repositioning deal that may have shorter leases and vacancies the senior market doesn’t want to take on board. So if you provide underwriting capability as well as capital, not only do you give certainty, you give time for asset management by the borrower, making it more efficient and cost-effective to bring in senior at a later date. So there are a lot of nuances in this market.”
Though the borrowers wanted pricing to be ‘on market’, they saw flexibility as more important. “Though we are a low-leverage borrower, we set more store by flexibility than we do by pricing,” Throssell said.
“We’re active with assets; we manage, we develop. Business plans often change from day one to day two and we want to do that either without recourse to the bank, or have a sensible discussion and not come out of the loan origination feeling a bit bitter about what we signed up to with the lender…
“We want both parties to win: it’s not: ‘they win, we lose’. We like pricing as tight to market as we can get it, but with the flexibility to do something with our assets.”
Some lenders had also been borrowers at an earlier point in their career. HSBC’s EMEA head of real estate finance Steve Willingham said his time as a borrower taught him that “the robustness of the loan structure is really important when things go wrong and should be given higher priority than the last 5bps of pricing.”
Radkiewicz, who is also responsible for borrowing by Pramerica’s bricks and mortar funds, recalled the lessons on covenants and structures learned after the financial crash, when he said lower-leveraged fund borrowers came under pressure from tight loan-to-value covenants.
“We were probably the lowest leveraged borrowers, but were still required to pay down debt at a time when banking liquidity was scarce.
“So covenants were incredibly relevant when they probably seemed, andseem, less relevant due to the low leverage of the underlying deals.” These days, Pramerica is focused as much on balancing deal structure and covenants as it is on pricing.
Covenants count for lenders
Covenants are equally important for lenders, said Deutsche Bank’s Kogan. “When it comes to flexibility, would I do something for an extra 25bps like not have an LTV covenant? No, that’s ridiculously stupid.You either decide to do some kind of high-yield profile and get paid for it appropriately, or you structure your loan how a senior loan should be structured.”
LaSalle’s Pottorff said leverage no longer seemed to be an issue. Operating in the high-yield part of the market, “we’re not constantly asked to give a bit more”, he said. “That’s stabilised, though you have to be in the right ballpark. A lot comes down to flexibility, can you see eye to eye, what’s the right structure, where do you as a lender get comfortable? Especially when you are that much closer to the risk edge.
“Can you be flexible, for example on LTV covenants? People think very carefully about downsides, especially when it comes to valuations.They’re thinking about cap rates, relative to what lenders can control, which is their own cashflow.”
With past lessons and potential downsides at the front of borrowers’ and lenders’ minds, the consensus was that the market is not as frothy as in 2007. Croft said M7 was not being offered huge amounts of debt.
“It’s difficult to see where the next 2008 is coming from,” he added. “But [the key thing is that] borrowers and lenders remember 2008. The debt markets, the specialists and traditional lenders, are being pretty sensible about what they are doing.
“I haven’t yet walked out of a meeting having borrowed 95% LTV at 38bps, which was not far from happening in 2007. It’s noticeable how lenders are not pushing themselves too far up the risk curve.”
Summing up at the end of the conference, CREFC Europe chairman Madeleine McDougall said Europe’s debt market seemed to be in a “goldilocks period, not too hot, not too cold” with borrowers and lenders, for now, “seeing eye to eye”.
Economic Outlook: Experts give glass half-empty/ half-full predictions on inflation
It seems all those jokes about economists are true, with two speakers on the conference’s opening day giving completely different messages.
First up, US policy analyst Pippa Malmgren, who has advised both the US president and London mayor, said in a video message that the world’s central banks are preparing for a bigger-than-expected inflation hike. “They’re not telling us, but are preparing for 3%, 3.5% or 4%,” she said. “They are going to let inflation run for a bit.”
This would be good for hard assets like real estate, so she said the market should prepare for a “melt-up, not melt-down. The picture won’t be linear, but property and equities pricing will surprise on the upside.”
Fabio Balboni, European Economist at HSBC Global Banking & Markets, took the opposite view: “We see inflation remaining weak,” he said.
The strength of the dollar and global factors continue to keep US core prices low, while in the UK, “we haven’t yet got the inflation the Bank of England would like and we don’t think it will rise soon”.
In Europe he predicted inflation of just over 1% next year and 1.7% in 2017.
HSBC believed interest rates would rise imminently, with the first US rise in December followed by a UK hike in February, but the upwards trend would be a “much slower path”.
Development: Cash is king for buyers in strong London development market
Canary Wharf Group treasurer Paul Stallard and JLL head of land and development Simon Hodson commented on the strength of the London development market.
UK listed property company Canary Wharf has ramped up development for this point in the cycle.
As well as developing offices and residential in a joint venture at the Shell Centre on the capital’s South Bank, it is developing Canary Wharf’s first big residential phase, starting with 345 units at 10 Park Drive.
Stallard said this scheme “is 75% sold in six weeks and to UK-based buyers. We have been pleasantly surprised by the speed and volume of sales, which will help to reduce leverage.”
Hodson’s JLL team has sold high-profile sites this year such as the Metropolitan Police New Scotland Yard building, near Buckingham Palace. He said demand for prime development opportunities means buyers nearly always pay in cash, as it’s faster than arranging debt.
“If anyone comes to us and says ‘(our bid) is subject to valuation and we’ve got a leading bank that is going to syndicate some’ we wouldn’t need to interview them.”
Stallard said Canary Wharf was looking at the private rented sector, where prices per square foot “were increasingly attractive compared to commercial space; it’s becoming a very valuable asset class.”
Hodson looked forward to a time “when London’s office developers let 100,000 sq ft and 100 flats at the same time, to companies to house their staff.”
Non-performing loans: Investors continue to milk NPL market as first froth disappears
The froth has been skimmed but plenty of cream remains for real estate non-performing loan portfolio investors, said a panel chaired by Situs Group’s Prasad Chaganti.
While debt finance for soured loans is harder to find and more expensive, they said a massive amount of European stock still needs cleaning up; €500bn said Chaganti, against expected sales in 2015 of €85bn.
With perhaps 75-80% of CRE deleveraging completed in the UK and Ireland, the panellists were focused on Spain, the Netherlands, Germany and Italy.
The market continues to evolve and “has become more calibrated” one speaker said — meaning that recent big-loan buyers “perhaps don’t feel as pressured to invest”, so it is less of a sellers’ market than it was.
There is also a lot more development, residential and land collateral in portfolios today compared to the chunkier commercial assets that secured earlier big loan package sales.
Chris de Mestre, managing director at adviser Sabal Financial, said: “Buyers are likely to become more selective and price accordingly.”
One speaker said the case for underwriting growth in value in Italy was quite poor and work- out times were longer, more like four years than 18 months, so values and pricing are typically lower than in other jurisdictions.
Chaganti added that in Italy, “it’s common to hear that people would like assets rather than loans, as loans can be hard to resolve.”
One investor said he felt that loan-on-loan finance has been less available since June and margins have risen by 100- 150bps, while structures offer less leakage to equity.
This has had an impact on the unleveraged rate of return and brought down pricing, but sellers will take time to factor that in.
The panel said spreads were back to where they were 18-24 months ago. But with interest rates at rock bottom, the total cost is still competitive.