Delegates at Real Estate Capital’s Europe Forum reported a rise in margins in the face of capital markets volatility and as traditional lenders hit their targets, allowing them to regain some ground lost to alternative debt providers. Lauren Parr reports.
With evidence of spreads widening in the commercial real estate debt market after two years of tightening, panellists at Real Estate Capital’s second Europe (2015) Forum, held at the home of the Institute of Directors on London’s Pall Mall last month, discussed where the market is heading next.
Debt margins have stabilised in the past few months and now appear to be inching up in some markets, the conference’s more than 130 delegates heard.
“Before the summer we closed a deal at very attractive pricing, but this has moved up now between 20 and 30 basis points,” said Alison Lambert, finance director, Europe at Oxford Properties Group. One delegate, the manager of two senior debt funds, reported that margins had risen by as much as 40bps for UK regional deals.
Part of the reason behind the rise revolved around banks’ targets for 2015, which speakers believed had already been met, meaning they were now cherry picking the best deals.
Paul Wilson, MetLife’s European real estate managing director, pointed out the impact recent volatility in equity and credit markets was having on floating-rate debt pricing. “Credit spreads are widening across the board and risk is up… we have to look at our debt pricing and react to that,” he said.
The macro-economic events linked to Greece and China have also contributed to spreads widening in the CMBS market, delegates were reminded, with the latest three European deals selling all or partly below par.
Bank of America Merrill Lynch’s TAURUS 2015-3 EU DAC, a €145.8m securitisation of two loans across three jurisdictions made to Starwood Capital and M7’s MStar Europe joint venture fund, reflected a widening in pricing after being sold in September at a blended coupon of 280bps – a weighted average discount of 1.8% to par across the deal.
It was also reduced in size, with BAML keeping more of the debt on its book than it had originally planned to retain. The underlying portfolio comprised 62 light industrial assets across France, Germany and the Netherlands.
The three most junior note classes in Goldman Sachs’ £646m Logistics UK 2015 CMBS, secured by a 42-asset UK portfolio owned by Blackstone’s Logicor, also sold at a 0.61% blended discount to par in July. The bank’s Reitaly Finance CMBS, a securitisation of a €181.95m loan to Apollo Global Management, secured against 25 Italian retail assets, priced at a blended all-in margin of 317.4bps after five of the six tranches were discounted.
“There have been macro events, although not (in themselves) sufficient to widen AAA bonds from 100bps eight months ago to 165bps today,” noted Bhavesh Patel, head of CRE loan distribution at Deutsche Bank.
He explained that a number of factors had affected wider asset-backed securities pricing, including “disappointment that the European Central Bank hasn’t stepped in as a big ABS buyer. A lot of the market was long (in ABS) at the start of the year, in anticipation that the ECB would do so.”
In light of the market’s wobble, panellists were relatively subdued in their projections for European CMBS issuance next year.
Investor Lee Galloway, executive vice- president at PIMCO, said he was “cautious about where volumes would be”, predicting a similar level to the €6bn forecast for the whole of 2015. Last year, the volume was €4.4bn.
Euan Gatfield, CMBS managing director at Fitch Ratings, said: “New supply causing spreads to widen suggests the investor base is not thick enough across the [CMBS] market, especially given year-on-year declines in ABS issuance.”
Asked if CMBS will continue to be relevant, Bank of America Merrill Lynch director Greg Clerc insisted: “Yes, definitely. It’s an interesting tool and banks wouldn’t have lent in some markets unless it was an option.”
He and the panel of CMBS experts agreed that CMBS worked in jurisdictions where the local lending market is not functioning properly, such as in Italy, as well as for special situations and very large deals.
The Forum was chaired by Marco Rampin, head of EMEA debt and structured finance at CBRE, who asked: could CMBS pricing be improved if investment banks stuck to quality and simplicity of structure?
Galloway joked: “I’d love to have a supermodel girlfriend but I’m never going to have one. Banks keep high-quality product on their balance sheets or syndicate it; the CMBS market is not going to get that. It’s more likely to be secured on secondary quality property and that’s why the market is not flying.”
Risk now a key topic
Aside from pricing, a key topic on lenders’ minds is risk. Property looks “pretty fully priced, while we’ve not yet seen the interest rate cycle play out”, pointed out Michael Acratopulo, UK deputy head of lending at Wells Fargo.
“Borrowing on central London assets now at 65% loan-to-value ratios would have been at 100% LTV ratios three years ago; cap rates are at all-time lows, rents are high and there is ‘noise’ in the financial markets. If interest rates rise, perhaps even to 3%, what will happen to yields?”
Facing more risk than was the case 18-24 months ago, lenders said debt yields and interest coverage ratios were more important to them than before. “If you lend on a property on London’s Bond Street at a 1.5% yield at just 50% LTV, that’s only a 3% debt yield,” said Nicola Bayes, senior loan syndications manager at Helaba. “Debt yield is about future proofing those loans; what is 60% today was 80% two years ago.”
Borrowers seemed to feel more relaxed about the environment, seeing few warning signs – although they also had concerns about central London.
Dan Nicholson, UK managing director at developer/investor Tishman Speyer, said that with yields in the capital as low as they are now, “the downside is pretty evident to see. So our core fund has been very cautious for the past nine or 10 months. We’ve pretty much called a halt.”
Colin Throssell, head of treasury at TH Real Estate, said he “was not convinced” that bubbles were forming in the property markets. “It is different this time. There is a lack of supply and more rental growth to come, and though it’s been muted so far, it will spread.
“If you look at relative returns, bonds and equities are still relatively depressed, which favours property, and regarding interest rates, we are looking at lower for longer. So for me, there’s some way to go; we’re nowhere near 2006-2007.”
A keynote address by Dr Gerard Lyons, chief economic adviser to London City Hall, delivered an encouraging message to investors by advocating that interest rates remain on hold to make sure bank lending and growth picks up.
The Bank of England has kept its official bank rate at 0.5% since March 2009 and has provided about £375bn of quantitative easing to date.
“If you hike early, you don’t have any room to manoeuvre if the economy takes a dive,” Lyons said.
“Normally the risk of waiting is that inflation becomes a problem, but inflation is not a worry at the moment. This suggests to me that, if anything, the Bank of England should wait.”
Core competition drives lenders into higher-risk debt territory
Senior lenders across the board have moved up the risk curve in the past 18-24 months, due to fiercer competition in the core part of the financing market.
Barry Fowler, Aviva Investors’ MD of real estate finance, said the insurer was “more open to development”, while Nicola Bayes, Helaba’s senior loan syndications manager, said the bank is “doing development now”, albeit sponsor-led and in a conservative manner.
Added Michael Acratopulo, UK deputy head of lending at Wells Fargo: “[UK Development lending] is a less crowded space, especially if you’re prepared to take letting risk.”
The sector is a core but small part of the US bank’s business; it is selective about “where and who it does it with”, especially if it is taking letting risk.
Matthew Pritchard, portfolio manager at Aalto, said the manager is looking at residential development opportunities ”in cities where there is demand, but construction has been low because banks have retrenched or developers have gone bust”.
Rising prices have led many lenders, including MetLife, to “pull back from central London trophy deals,” said European real estate MD Paul Wilson.
But financing regional UK assets, particularly secondary ones, provides an opportunity to “structure a really interesting deal and get rewarded for it”, said Acratopulo.
Aalto looks for “esoteric assets”, Pritchard said. In January it structured a 10-year private placement secured against a portfolio of motorway service stations.
James Wright, head of real estate finance at Capita, asked if competition for core deals had made alternatives easier to finance. Wilson cited student housing as an area of interest, but Acratopulo stressed that lenders must understand operational risk. “Alternatives are great but you need to be careful,” he said.
Hotel operators noted the return of bank lending in their sector. Duncan MacPherson, Starwood’s head of European capital markets, said in 2011-12 “a ‘no bed’ rule prevailed for lenders, so if you tried to finance a big acquisition there wasn’t any source of debt.
“But lenders with a previous specialism in the industry have crept back in [in addition to other banks]. Today 30 people will look at £100m tickets; at the same time, margins have more than halved over the past three years to a little over 200bps.”
With the UK more competitive, investors and lenders have entered new territories in the past 12 months. MetLife has eyed opportunities in Ireland and the Netherlands and is open to Spanish deals for sponsors it knows.
Colin Throssell, head of treasury at TH Real Estate, believed Spain and Italy were no longer news and “the next stories will be Portugal, Poland and Turkey”.
Loan buyers prepare to splash out in new European waters
New markets are opening up for non-performing loan buyers, namely the Netherlands and Romania and at some point Italy and Greece.
In a session moderated by Clarence Dixon, CBRE’s global head of loan servicing, Russell Gould, director of CRE finance, EMEA, at Citi said the market is “very deep and wide”, with at least another three years of NPL portfolios coming, but not all will be capable of being financed.
While deleveraging in the UK and Ireland is coming to an end, Gould said “different types of portfolios and geographies are being brought to the market”, such as Dutch bad bank Propertize’s potential sale of its €4.3bn (net) real estate book.
German bad bank FMS Wertmanagement “plans to use high liquidity in the [NPL sales] market over the next 18-24 months”, said Jose Holgado, head of commercial real estate at FMS.
The bank has launched the sale of a €500m German loan portfolio called Project Samba, backed by houses and apartments, as well as some commercial assets, and is said to be considering two country-specific portfolio sales for its Dutch and Italian sub- and non-performing loans.
“(Wider) European bank deleveraging has picked up in earnest in the past 12 months,” said Ahmed Hamdani, MD at HIG International Advisors, “whether by Italian banks, UK or German banks selling foreign exposure, or Austrian banks selling eastern European exposure”.
He said “a lot is happening below the radar”, but that some sales have failed, including a €2.5bn Romanian book disposal. “There’s only €40bn in all Romanian banks,” he said.
Gould said: “If you are going to go into a new jurisdiction you need to know there’ll be more than one deal to do to make it worthwhile.”
As the opportunity shifts, NPL buyers face multiple challenges — not least tricky legal regimes.
“The first thing we look at is ‘can we enforce?’” Hamdani said. “Proposed changes to Italy’s legal framework are moving in the right direction but there is further to go [to facilitate the extraction of NPLs].”
HIG’s next question is: “Who’s going to work it out for us?”
Portfolios are becoming more diverse, with almost all NPL books now comprised of or including non-commercial real estate assets, including some smaller business, corporate, leasing and residential loans, as well as land and incomplete developments.
Yet “the servicing industry away from core European markets is still in its nascent stages”, said Hamdani.
Non-bank lenders aren’t always the most healthy alternative
While alternative real estate lenders have grown, some may be struggling to deploy funds as banks stage a comeback.
At the Forum’s opening panel, Oxford Properties’ FD Alison Lambert said debt funds were “pretty expensive”. But even allowing for a recent uptick in margins, she said it is “a great time to be a borrower because liquidity is there”.
A participant in a refinancing panel led by Capita’s James Wright saw “a wide range of risk appetites led by different regulatory environments. We’ve talked to alternative lenders but have not done deals with them so far. Senior lenders in the UK and Germany have been more competitive, cheaper options.”
Louis d’Estienne, AXA Investment Managers’ pan- European senior transactions manager, found mezzanine lenders too expensive and was “generally happy with banks… if we can’t find finance on value- added investments we will go to a fund backed by an insurer”.
Belinda Chain, partner and head of asset financing at Europa Capital, said the firm rarely took mezzanine debt and it needed to be priced in the single digits, as “if it’s in the teens it’s no different to equity, so why take the risk?”
A key conference theme was established lenders taking whole loans with an eye to syndication; for junior debt, borrowers preferred this to the execution risk and legal costs of going to an alternative lender or debt fund, for example.
“The terms are not a sufficient improvement to justify the significant expense and hassle of borrowing from a debt fund,” said one borrower. “Traditional lenders provide better timing and certainty,” added another.
One UK clearing bank lender said it was important to be able to write big tickets and bring in other providers via syndication: “Having a single point of offering must help, especially on an acquisition. Borrowers have a lot going on and don’t want to worry about it.”
Tishman Speyer’s UK MD Dan Nicholson said: “Enough people can write big cheques; for a little extra pricing we’d prefer to take out the risk.” He added that because “often the only way is to buy stuff first and sort debt out afterwards”, there was also an argument for maintaining relationships.
Chain said: “With traditional lenders there’s a history, a pattern to working. You have to re-learn this with alternative lenders; you must be prepared to invest that ‘argument time’.”
But Colin Throssell of TH Real Estate, which runs a debt fund, argued “we’re very quick; we can get credit done in two days. Banks still take time over things we find relatively unimportant.”
Throssell said banks had an advantage in financing core product “where traditional lenders can compete on pricing and flexibility of covenants”.
As interest rate rises look unlikely soon following recent volatility — and the US Federal Reserve putting off a hike again — fixed-rate lending costs have bucked the trend by falling.
Barry Fowler, Aviva Investors’ head of CRE lending said that while the financial markets were “grumpy”, the patient had yet to stop taking the quantitative easing “drug”. Following the Fed’s decision not to raise rates, 10-year gilts, “which were over 2% three months ago, are now 1.62%, which is very accretive” for investors using debt. “It means fixed-lender insurers can undercut banks on some deals”.
Generally, investors said they preferred to maintain control. “Even if pricing is higher than in 2007, it’s important to have a relationship with a bank, not a counter party,” d’Estienne said.
Great Portland Estates finance director Nick Sanderson talked about the painful process in 2012 of trying to repay a 36% loan-to-value bank loan that had later been sold to a CMBS conduit: “That was our hardest deal; we couldn’t get hold of the servicer.” He stressed GPE’s emphasis on who is behind a loan, as “it’s more than just money; it’s about relationships”.
Chain said Europa asks for consent over syndication participants, but moderator Madeleine McDougall, head of Lloyds’ institutional client team, questioned how often that was granted.
Debt funds defend their raison d’être as the banks strike back
Real estate looks more attractive than other fixed-income investments and now investors have accepted the product, property debt funds continue to draw capital. Yet with the return of liquidity, new lenders are struggling to gain market share.
Richard Urban, independent non-executive director at Rivington Pike, who chaired the panel, said: “Senior debt funds originated from the vacuum left by banks. Now banks are back has the thesis weakened?”
Venn Partners’ MD Paul House felt it was “impossible to beat banks (at their type of lending), as they raise funds very well and can offer low cost of capital in volume. There’s not a huge amount of money in senior debt funds (because fees are low) so you need volume. We will see if they can survive.”
GreenOak partner Jim Blakemore added: “There is a place for them but the thesis that said: ‘banks have gone, so it’s the best lending opportunity for all time’, was flawed.”
Aalto’s Matthew Pritchard said the firm had moved away from senior debt investing for pension fund investors needing 3% margins and 65% maximum LTV ratios. “Those opportunities have largely dried up,” he said. Martin Healey, CPPIB Credit Investments’ head of private real estate debt, said the Canadian pension fund couldn’t “get interested in today’s low senior margins”.
In an earlier session on debt underwriting, BAML director Greg Clerc stated: “It would be great if senior debt funds got mandates to invest in CMBS, particularly if they can’t invest enough.”
Blakemore pondered the viability of a fixed-rate market, which would be interesting as it’s a product banks don’t offer. “Amazingly, no-one in this market wants fixed-rate debt; if it was more accepted, spreads would fall, which would be more attractive to borrowers.”
Managers are still interested in mezzanine debt, despite returns having been slashed. Blakemore said: “There are definitely good opportunities. If you can get comfortable on the portfolio side you can generate 11-12% gross. In terms of the all-in rate, the margin is great.”
But he said previous pressure to invest in mezzanine debt led to poor results for investors. “You need to be selective where yields are well above peak value, especially outside the UK.”
Healey said CPPIB’s main concern for any debt strategy was to “understand the risk”. With regard to its past three debt fund investments, he added: “Two are likely to hit target returns and one will be a long way short. Only one gave us the risk profile we expected and only one deployed all the capital we expected.
“All have or will make money; there are no train wrecks”. CPPIB would consider investing with the same managers again, but “we felt we could do better on the direct side” Healey said.
CPPIB has invested $4bn in CRE debt, with another $500m in the pipeline. This would have been impossible via a fund, as one investor can’t dominate, unless the fund invested $20bn!
Another problem is that “markets don’t sit still for a fund raising period and it’s hard to match the cycle with the fund”.
Participants agreed that the number of debt fund lenders is likely to fall in the next three years. “Lending for specialists will evolve, but some platforms might find it tough to keep going, especially if traditional lenders go up the risk curve”, said Tishman Speyer’s Dan Nicholson.