Germany’s debt dilemma

With German property lending margins moving ever lower, delegates at Real Estate Capital’s first Germany Forum debated the challenges of hitting return targets and spotting opportunities in a crowded market, reports Alex Catalano

REC 05.15 - 30

With a liquid and fiercely competitive market for real estate, panellists at Real Estate Capital’s inaugural Germany 2015 Forum, held at Kempinski Gravenbruch, Frankfurt, last month, discussed whether lenders could keep chasing margins down and where to find value.

Germany’s real estate market is flush with cheap debt. “There is an oversupply of bank finance and that is a challenge for an international bank,” said Jürgen Helm, HSBC’s head of German real estate.

Deutsche Bank director Jörg Oestreich concurred: “Everybody is chasing exactly the same assets and that is why our lending margins have become so low.”

Forum panellists discussed how long the downward trend could be sustained. “Good-quality office buildings were being financed at 130bps last year, now it’s 75-80bps,” said Alexander Saur, general manager of Natixis Pfandbriefbank.

“But new regulations are forcing us to increase our equity. How can we do this when we are earning less with lower margins? It may come to the point where we need to increase our spreads to be cost-efficient and generate profits to increase our equity.”

 Mezzanine market “too tight”

The hot market is also hitting junior lenders. “We stopped classic mezzanine lending in Germany about a year and a half ago because from our viewpoint, the market was getting too tight,” said Rene Geppert, director of Chenavari Investment Managers. “We have promised our investors mid-teens returns.”

Norbert Kellner, Helaba’s head of real estate debt capital markets, thought margins may have bottomed out. “On our existing cost basis, we really can’t go much lower. We expect our costs as a lender to increase – capital costs, liquidity costs, regulatory requirements; due diligence is more work-intensive,” he noted.

However, given that many German banks are real-estate focused, intense competition is expected to keep debt cheap. “There are banks that can only lend in Germany, so you are not only limited on the asset class but on the country. As long as that continues you will be doomed to lend at low margins,” predicted Oestreich.

Isabelle Scemama, AXA Real Estate
Isabelle Scemama, AXA Real Estate

International lenders, who can play in other jurisdictions, said Germany is a “difficult” market. Isabelle Scemama, head of funds group at AXA Real Estate, Europe’s leading alternative property lender, said: “Our German portfolio is very small compared to the German market, at 11%. That’s due to the very low spreads – we consider this market very expensive and we struggle to invest here.”

Consequently, AXA is now targeting the US market and, in Germany, unsecured loans. “German mortgage lending is so expensive that we prefer to lend to property companies that are lowly leveraged and offer attractive returns,” said Scemama.

Helmut Mühlhofer, Allianz Real Estate’s head of debt and capital markets, was also looking further afield. “The German market is too competitive right now from a pricing perspective,” he said. “There’s better business for us in France. Benelux is an interesting market and then Spain, followed by Italy.”

Others lenders are finding business in providing the kind of loans that don’t fit neatly into the German pfandbrief system – bridging finance or providing whole loans that stretch beyond the senior loan-to-value ratios that are suitable for funding via the pfandbrief market.

Norbert Kellner, Helaba
Norbert Kellner, Helaba

Helaba does the latter, syndicating parts not only to other banks but “more and more to alternative lenders and debt investors,” said Kellner. “It’s not really an easy market – we’re all looking closely at the margins and fee structures of our loans. But given the relative margins, there are a lot of debt investors that appreciate the opportunity to co-lend with us.”

Natixis, meanwhile, seeks to earn fee income from more complex deals. “We’re trying to shift our business like that, more as an adviser, partner, someone who can structure clients’ requests and after the transaction is settled, step back into the traditional position of being a balance sheet provider of the senior debt,” said Saur.

The balance between interest rates and compressing yields also exercised panellists. Michael Ramm, JP Morgan Asset Management managing director and co-head of acquisitions, said: “The five-year forward swap is 1%. We live in a low yield environment for the foreseeable future. Our capital will return relatively little if we have a Japan scenario. That is the big question.

“Is 4% the new 5%, or 3% the new 4%? A lot of capital is moving into the market and it’s not stopping; a lot of investors are looking for European real estate exposure.”

Prime German opportunities are crushed under weight of capital

Last year, €52bn of real estate changed hands in Germany, the biggest post-crisis rise in deals. This weight of capital has driven down prime yields, with high prices making life difficult for both investors and lenders.

Gerhard Meitinger, pbb
Gerhard Meitinger, pbb

“Everybody is asking for higher leverage,” said Gerhard Meitinger, pbb Deutsche Pfandbriefbank’s head of real estate finance in Germany. “We are finding solutions combining with mezzanine providers or, in some special situations, we do a stretched senior loan if the cash flow is right.” His concern is declining asset quality: “Most investors are now going to B or C cities and C or D locations.”

Michael Ramm, JP Morgan Asset Management’s MD and co-head of acquisitions, saw value in value-added assets with short leases or vacancies.

“There is still a healthy spread between prime and secondary yields, though its is narrowing,” said Ramm. He tipped “not too small” cities outside Germany’s big seven. “Yields are still too high compared to primary markets.” Managing partner Peter Jun shared this view for the opportunistic capital Arminius manages: “We’ve had most success turning around offices, generally prime city secondary locations or prime assets in secondary cities.“

Peter Jun, Arminius
Peter Jun, Arminius

For running income, Jun favours buying distressed loans. “We use those to acquire the assets, sometimes in a friendly way, sometimes not friendly. For us, yield is driven by some of the income stream from the loan interest and some of the enforcement and sales proceeds that can be achieved.”

Alternative sectors not on big players’ radar are also an option, but Investa’s managing director Rainer Thaler noted that yields on “anything residential, be it student housing or micro-apartments, are now below a normal rated office building.”

Hubertus Baeumer, co-head of institutional property solutions at Union Investments, cited “undersupplied branded budget hotels — it’s about 8% or 9% of the market, compared to 30% or 40% in the UK”, he said. “Traditionally it’s seen a higher yield than four–star hotels.”

Torsten Hollstein, MD at CR IM, said that with so much competition, “you need to be agnostic about asset classes if you want to make money”.

Non-bank lenders jump into structured property debt gap

Given the crowded and fiercely competitive German banking market, debt funds and other non-bank lenders find the going tough. Nonetheless, they are picking up business, often teaming up with senior lenders.

Jan Peter Annecke, Münchener Hypo
Jan Peter Annecke, Münchener Hypo

“We are more limited in the product we can offer customers, and this is where alternative lenders can jump in,” said Jan Peter Anneke, Münchener Hypothekenbank’s head of commercial real estate finance.
With large parts of Germany’s banking system focused on lower-leverage product that can be funded via the pfandbrief market, alternative lenders can help with structured debt.

“We don’t finance prime or core, as they don’t fulfil our return expectations, but more than 50% of German stock is not prime or core,” Patrick Züchner, chief investment officer at CAERUS, said. CAERUS also analyses deals then taps senior banks to see if they suit.

Non-bank lenders seeking opportunistic returns will also underwrite entire loans. “We do whole loans where we can syndicate, or we are somehow involved in the equity, because as far as I can tell mezzanine doesn’t work,” said Chenavari director Rene Geppert.

Rene Geppert, Chenavari
Rene Geppert, Chenavari

GreenOak’s investors are UK and other European pension funds looking for additional yield for fixed-income portfolios or seeing real estate debt as an equally rewarding, but easier, way to deploy capital than buying assets.

“Our product is relatively high-yield, high-single-digit whole loans designed to fulfil current income,” said partner Jim Blakemore.

Debt that needs quick arranging provides another opening. “We did two deals in Germany last year, where we had to underwrite in two weeks. It was a way to get a better strike spread,” said Isabelle Scemama of AXA Real Estate.

But for smaller loans, competition from local sources such as family offices can sink deals, said Geppert. “Two weeks before closing, a family office came along that liked the asset, no questions asked, no security, they didn’t even negotiate on the return structure. As an institutional investor we can’t compete with that.”

Loan sales are less of a big deal in Germany as banks sit it out

“This cycle, banks are not offering huge portfolios attractively priced on a silver platter to investors,“ said Ruprecht Hellauer, managing director of Albulus. Panellists sought to explain why the wholesale clearances seen in other European countries have not happened in Germany.

Clarence Dixon, CBRE
Clarence Dixon, CBRE

Clarence Dixon, CBRE’s global head of loan servicing, noted that most non-performing loans were in ‘bad banks’ and while “deals have happened, they’re not in a public format, they’re under the table or individual, granular deals”.

This was corroborated by José Holdago, ‘bad bank’ FMS Wertmanagement’s head of commercial real estate work-out. “More than 90% — €20bn — has been wound down on individual decisions and sales,” he said. “We have wound down quite significantly, despite our low funding cost, having had five years to wind down our exposure. The question is how. You don’t sell the loan — this is the most expensive exit. You go and try to make a deal with the borrower.”

Thomas Wiegand, MD of Cerberus Deutschland, pointed out that unlike in 2004/5, when German banks shed large non-performing loan portfolios, this cycle the assets are better

Thomas Wiegand, Cerebus
Thomas Wiegand, Cerebus

quality. “Even if they have 200% LTVs, they are still generating rents. Banks can say, ‘I have a low cost of capital, so I can sit it out.’ For the past three years that wasn’t a bad decision.”

Apollo Global Management partner Ulrich Ahrens said that though a lot of assets were changing hands, “it’s not big, distressed sales at 30-40% discounts, which we like a lot. NPL ratios aren’t big enough for banks to justify disposing of large volumes. I’d like to see that, but I’m not expecting it.”

Hellauer was more upbeat: “There are opportunities, but you have to do a lot more work to find them and buy them from banks. Unfortunately it’s not big portfolios pushed into the market, but we’re quite happy about the opportunities.”

Large and liquid lending pool allows borrowers to splash on debt

“Whatever you want to do, liquidity is there,” Deutsche Wohnen chief financial officer Andreas Segal told the Forum. “Now is the time to think about your long-term goal, because it is too easy at the moment and potentially it won’t stay as it is.

“There are alternatives, which are important, but the German mortgage banking market is a strong base for us.” Deutsche Wohnen recently refinanced €1.4bn with two banks.

“It is also possible to place a bond for €1bn or a convertible for €500m. Ticket size is not an issue today,” said Segal. “We like to select the right timing and instrument case by case.”

Commerz Real also relies mainly on bank partners. Head of group finance Barkha Mehmedagic said: “We have a long-term relationship to create. In difficult times, we want the flexibility to change collateral, portfolio view and sell assets. But no single bank has more than 20% of our portfolio debt.”

LaSalle Investment Management runs various styles of vehicles. “Financing follows investment strategy and we rarely go beyond 55% LTV levels, maybe up to 60% in some cases,” said European financing head Roberto Carrera.
Carrera said that besides leverage and pricing, having enough headroom on financial covenants was vital. “Having a reliable counterparty is also important to us,” he said. “Insurers are newer to lending, but in it for the long haul. There’s a question mark over how long debt funds will be around for.”