Investors want control while banks stay out of the game

Speakers at LBS’s real estate conference tackled the travails of capital raising, writes Alex Catalano

Debt and demanding investors were the themes dominating London Business School’s real estate conference this year. Deleveraging the UK banks is going to take three to five years, according to most of the panellists.

“We’ve seen a stop-start process and that will continue. We won’t see a wave of deals. Banks acknowledge they don’t have the capital to take the hits,” said Angus Dodd, Lone Star’s UK real estate managing director.

Banks will structure deals using vendor finance at below market rate or take equity stakes. Until their balance sheets are mended, debt will remain in short supply.

“It improved in 2010 but it has come off the boil. The switch turns off quickly,” noted Desmond Taljaard, Starwood Capital Europe’s chief operating officer.

Dale Lattanzio, managing partner of DRC Capital, pointed to a structural shift away from bank lending towards a US-style financing market with more lending by new entrants: institutions and debt funds.

According to Andrew Radkiewicz, managing director in Pramerica’s high-yield debt group, larger institutional investors are getting more comfortable with debt and making larger-scale commitments. “Debt is not about the capital stack and LTVs – it’s driven by real estate,” he said.

Scope for covered bonds

Bill Hughes, L&G Property’s managing director, said: “There is scope for covered bonds and pension funds could play a big part. It won’t just be long-term money; there will be more opportunities. We will see a lending market that is pricing appropriately.”

Michael Pashley, AREA’s chief financial officer, said it could get opportunity fund returns by lending for a preferred return over senior debt, and Susan Lloyd-Hurwitz, LaSalle Investment Management’s European managing director, highlighted the £75m of mezzanine finance it provided for Black-stone’s recent logistics purchases.

Peter Denton, who has just joined Starwood from BNP Paribas, thought mortgage REITs could help. “They could be part of the solution for new loans, re-engag-ing with the regions; not lending £50m or £100m, but £1m.” Starwood’s own US mortgage REIT has loaned on some German properties: “This is on secure cash flow, not loan-to-own,” noted Taljaard.

Lattanzio said pension funds and insurance companies were using opportunistic capital to test debt investing strategies. “This will broaden geographically. There will be more North American participation, because spreads [here] are 200-400 basis points higher than in the US,” he said.

But Europe’s real estate debt is maturing, and panellists agreed that new lenders wouldn’t be arriving quickly enough. The money raised by debt funds is a “drop in the bucket”. Institutions such as insurers and pension funds never move quickly at the best of times, but all the uncertainty surrounding the new Solvency II regulations is also slowing them down.  “The big gap has to lead back to asset repricing, particularly of secondary and tertiary property,” said Dodd.

Prime property might also come off the boil a bit. “I don’t think it is priced properly,” said Noel Manns of Europa Capital, noting that supply was due to increase. “There is €24bn of good assets set to be liquidated by German open-ended funds.”

Interestingly, residential real estate seems to be creeping onto investors’ radar. Sir John Ritblat is a big fan of the sector, and argued in its favour in his opening address. AREA, which is raising its fourth fund, is looking at increasing its allocation; it backed a central London developer on a preferred return basis in its current fund.

Equity side is no easier

Raising equity for real estate is also as tough as it’s ever been. “Fundraising is at an all-time low. Investors are looking at infrastructure,” said Christophe de Taurines, CEO of Capital & Marketing Group. He noted that insurers are “very dubious” because of Solvency II. “The rules of the game in the capital markets are changing constantly. There needs to be more certainty for the market to stabilise, and that’s a few years off.”

Fund managers all highlighted the “limited bandwidth”. Investors want more focus and more control. “In the past they chased returns; now they want to invest in safer markets. Now they are specifying x% in certain markets, and restricting how much can be invested outside main locations. The return requirement has come down to the high  or middle teens; it was the high 20s to mid-teens before,” said Pashley.

Speed of execution also came up. “You need discretion, but investors want more control. That slows things down,” noted Lloyd-Hurwitz. Taljaard agreed: “It’s hard to be opportunistic with one hand tied behind your back.”