REAL ESTATE LENDING
German lenders may have to move up risk curve to sustain business in UK, reports Alex Catalano
German banks inject an important dose of debt into the UK property market: last year, this totalled £3.9bn, or 16% of all new lending. Currently about nine lenders, all veterans, are active, although a couple went very quiet during the financial crisis.
With a few exceptions, they are sticking to the bottom end of the risk curve: core offices, retail and logistics, primarily in London and the South East. Unfortunately for them, this is very crowded turf.
“Finding new business is a real struggle at the moment,” says Mike Worley, head of Bayern LB’s UK property lending division. “The problem is that there’s a lot of equity around in central London. There are buyers such as Middle Eastern and Far Eastern sovereign wealth and pension funds that don’t need to borrow.”
There are also more lenders now. “The UK clearing banks are coming back into the market, so that’s making life tougher,” says Charles Balch, head of real estate finance international, UK & CEE at pbb Deutsche Pfandbriefbank. “We’ve seen that both on senior debt, and on stretched senior and mezzanine provided by new lenders.”
Pfandbrief funding at home gives German players an edge in away game
It is easy to think of the German lenders en masse, but they come in rather different shapes and sizes. They range from Deutsche Bank, in a league of its own as an international investment bank (see top panel, opposite page); to stand-alone real estate specialists such as Aareal, which is quoted; pbb Deutsche Pfandbriefbank, which was bailed out and nationalised; the co-operative MÃ¼nchener Hypo; plus an array of state-owned, regional landesbanks.
Their rationale for operating in the UK is the usual one: diversification, serving international clients and relatively juicy returns. Germany has too many banks and is very competitive; margins can be as low as 150 basis points. “For an equivalent quality asset, the UK offers twice the net profit for the same risk as Germany,” one lender told us.
Most German banks benefit from a cheap funding source: issuing pfandbrief, or covered bonds, backed by their real estate loans. This market held up very well during the financial crisis and since then the cost of pfandbrief funds has declined sharply.
In the past few weeks, this cost has hiked slightly, to 1.1% for five-year pfandbrief funding, but this is still only a few basis points or so above the Euribor swap rate.
However, pfandbrief funding will only cover up to around 40% of a UK asset’s value, so the remainder has to be funded from other sources. Loan-to-value ratios have crept up a bit lately, but aren’t breaching the safe 60-65% zone.
According to Emma Huepfl, co-founder of investment manager Laxfield Capital, which originates for MÃ¼nchener Hypo in the UK, borrowers are not pressuring lenders to raise leverage levels. “On a pipeline of £21bn of lending opportunities that we track, the average LTV sought is 55%,” says Huepfl.
Pbb’s Charles Balch notes: “Borrowers are looking for more flexibility and relaxation by keeping a lower leverage point so they have more control.”
For those who do want more debt, there is plenty of mezzanine and other top-up funding around. Senior lenders are happy to work with that, as long as they are comfortable with the provider and the deal.
One banker says the bank has walked away because it felt the overall leverage was such that it was uncomfortable about one deal’s future stability.
Meanwhile, margins on UK senior debt are down significantly to 200-250bps for the best properties. “People are quoting lower than they did 12 months ago, especially for central London assets. There is a lot more competition and people are pricing to win,” says Paul Stone, head of Aareal’s UK branch.
Opinion is divided on how much further margins will fall this year. A few think they could drop to 175bps, but most think they will still be above 200.
Tough targets for pbb
His bank wrote €900m of UK business last year, less than it had aimed for, and wants to step up from that figure. “They are tough targets, but achievable,” says Balch.
This illustrates one divide: the German banks with small teams and a tight focus on prime London/M25 are finding the deal flow to be limited. For example, BayernLB’s new lending is aimed exclusively at customers that have bought, or plan to buy, assets in Germany as well as the UK, offering them origination and an ongoing client relationship in London.
Dekabank, meanwhile, plays very much in the same prime space as its fund management arm. Banks that take a slightly wider view of the UK property market are seeing a fuller pipeline of deals.
The big question is how far German credit committees will let their UK lending go off-piste. Very few are prepared to depart from the mainstream sectors, although hotels are OK with some; Deutsche Bank is keen on lending against them, for example.
“Hospitality is interesting at this point of the economic cycle,” says Gad Caspy, DB’s head of European real estate.
Pbb will also look at funding hotels, but at a lower leverage point; Helaba funds them; MÃ¼nchener and Aareal will consider them; and late last year, Dekabank exceptionally teamed up with Crédit Agricole to arrange a £290m refinancing of the Savoy in London.
International mega-deal territory is hunting ground for big beast Deutsche Bank
Deutsche Bank is “open for business throughout the UK”, says Gad Caspy (pictured), DB’s European head of real estate.
DB is a big international beast and plays in a different league to other German banks. On senior debt for stable assets, its playground is the £100m-£750m range.
“We will underwrite significant tickets on day one,” says Caspy. “Most of these deals are distributed, either through loan syndications, rated or unrated CMBS deals or participations. We are seeing increasing demand from borrowers searching for yield and with capital to deploy.”
The latest Chiswick Park refinancing is typical: a £380m senior loan on the business park in West London, which has been securitised as a three-year, unrated CMBS.
DB also finances the rest of the risk spectrum: transitional assets that need work and special situations, both as single assets and portfolios.
Over the past 18 months, about 60% of DB’s European real estate lending has gone into the UK. This level is about twice the bank’s longer term average.
“We’re seeing a rush into UK lending. Spreads are tightening and competition has increased,” says Caspy. “The rest of Europe is becoming interesting compared to what you can find in the UK. We have closed deals in Spain and Italy and are looking to close a couple in the Netherlands. Going forward, I don’t think we can maintain the proportion of our business that is currently in the UK.”
Housing sector gains backing
Residential is also gaining traction. “We will look at residential development for sale, working alongside UK clearing banks, and at residential investment as well,” says Balch. This would be in the better areas of London, in sensible lot sizes. Helaba and MÃ¼nchener Hypo, which lends through Laxfield Capital in the UK, are prepared to look at student housing.
Most German banks claim that they are prepared to lend outside the core London market, and for regionally dominant shopping centres or key logistics assets, they sometimes do. Portfolios, by their nature, also can command a wider spread. For example, Aareal provided senior debt for F&C Reit’s £248m purchase of a three-strong provincial shopping centre portfolio.
“When you go outside London, the competition reduces somewhat,” says Paul Stone, head of the bank’s London branch. “You get more of the traditional players that have been in the market for longer and have property experience within their team. We’ve always been happy and prepared to follow the right borrowers, whom we know well, to good locations outside London.”
Landesbank Baden-WÃ¼rttemberg, which has previously tended to take syndicated debt, has now started originating and provided £70m for EPIC’s three office properties in Mayfair, Birmingham and Bristol. “We take a selective approach, driven by the deal,” says John Cole, UK head of property finance. But regional offices still tend to be the exception, although that may be changing.
Meanwhile, it is anyone’s guess whether competitive pressures and lower margins will drive German lenders beyond lending to core property products only.
“We will underwrite the borrower’s business plan,” says Richard Bentley, head of UK real estate finance at Helaba. “Typically, we look to have two exits; one is achieved through the business plan, the second is an alternative. That’s important to us.”
Balch notes: “That’s where underwriting is going to come in, either taking leasing risk, or looking at slightly more secondary assets. That’s a difficult position for everyone, because the tenant market remains weak.”
Postbank and pbb face uncertain UK future
Pbb Deutsche Pfandbriefbank and Deutsche Postbank are both big players in the UK, but there is a question mark over their future, as both face a change of ownership.
However, there is cause for feeling optimistic about the likelihood of their staying in the UK. The sale of Eurohypo’s UK origination team and performing loans to US bank Wells Fargo shows that senior debt businesses are attracting serious interest. International buyers are looking to run a conservative operation that produces sensible returns.
The German government promised the European Commission to reprivatise pbb by the end of 2015. Its impaired loans were unloaded onto a bad bank, it has successfully been issuing pfandbrief and originating new business; at €3.4bn, the UK accounts for 14% of its portfolio. One challenge is its high funding costs for loan-to-value ratios above the portion that can be backed by pfandbrief.
Deutsche Postbank’s future in the UK is murkier, because its parent, Deutsche Bank, considers the UK real estate business to be non-core. It could be sold or the best part of €2.5bn of loans run off. In April, DB sold Postbank’s US retail real estate lending business and its $3.7bn loan portfolio, to Union Bank, a subsidiary of Mitsubishi UFJ.
Losing either bank in the UK would be a blow. Like pbb, Deutsche Postbank is a broad spectrum lender. Earlier this year, with HSBC, it provided Argent with £104m for two King’s Cross housing developments.