Maturing property cycles, political uncertainty and the rise of debt funds all featured at Real Estate Capital’s third Europe Finance Forum, writes Jane Roberts.
If, as Confucius declared in one of his many aphorisms, “The cautious seldom err”, then Europe is safe from bad real estate lending this time around in the property cycle.
Judging by the discussion at Real Estate Capital’s third Europe Finance Forum 2016, held at the Institute of Directors in London on 29-30 September, the further through the cycle that the industry moves, the more cautious borrowers and lenders seem to become.
Speakers and delegates are most careful of all about the UK market for obvious reasons: it is furthest through the current cycle and now has the added challenge of dealing with the uncertainty thrown up by the Brexit vote.
But it’s not only in the UK. German lenders spoke of the continuing fierce competition for business, in Germany, France and increasingly in the Netherlands, and the need to maintain discipline in pursuit of deals.
For those investing mainly or exclusively in the UK, it’s a case of continuing to look for lending and investment opportunities, but seat belts are being fastened for a bumpy ride. “We anticipate a period of uncertainty and there’s a marked consensus of a value correction to bottom out at 10 percent, maybe 15 percent by the end of 2017,” said Christoph Wagner, director of debt strategies at TH Real Estate. “The question is, where is the occupier market ultimately going to come out?”
Michael Acratopulo, deputy head at Wells Fargo which lends in the UK and Ireland, said the US bank tries to underwrite “through cycles” and had not changed its approach to lending. Nevertheless, he readily agreed that the current cycle was hard to read and that Wells was “trying to be more thoughtful around Brexit.” On the one hand, “construction has been restrained this cycle, leverage has been relatively well-marshalled, there are still good amounts of liquidity out there, demand is holding up pretty well…” he observed. “On the other hand, values seem very high, arguably artificially underpinned by QE. Rents are pretty high in some markets, though not all. UK GDP is probably going to be slower than it was. And there’s political uncertainty out there, in the UK and beyond.
“So, we need to be mindful that time has elapsed and where some of those negative things are pointing, but also that there are still some positive indicators in our market.”
In the borrowers’ camp, Great Portland’s finance director Nick Sanderson told delegates that the London office specialist has now worked its leverage down to the high teens percent. “There clearly is going to be more uncertainty,” he said. “Our sense was that there was going to be an inflexion point and the likelihood is, Brexit has brought that forward.”
Risk appetite cools
Two more borrowers, Andrew Rogers and Rob Mills of UK-focused private equity firms Frogmore and Clearbell, said they found lenders still had appetite to lend on the kinds of asset management-intensive investments they make, but the number was reduced. Mills, a partner at Clearbell, has found “people’s risk appetite post-Brexit has definitely cooled.” The cost has gone up too, but luckily for borrowers the fall in the sterling forward swap rate more or less cancelled out the increase.
Rogers, Frogmore’s group treasurer, said: “Leverage has come down 5 percent, from 65 percent to 60 percent LTV and pricing is up by 25-50 basis points,” metrics echoed by Starwood’s debt capital markets head Duncan MacPherson, TH Real Estate’s head of treasury Farrah Brown and others. That is for deals with at least some cashflow, with Rogers adding that “speculative development finance is incredibly difficult and has got more challenging this year. You’re really looking at alternative lenders – and it costs. Refurbishment is slightly better because it’s quicker and you have more insight on where letting markets might be in a year’s time than in two or three”.
Lenders Mike Shields of ING Real Estate Finance and Wagner of TH Real Estate, both said some institutional cross-border capital had been turned off the UK or was at least on hold. “It’s difficult for overseas investors to say they are going to allocate more capital to this market rather than others where there’s more visibility,” said Wagner bluntly. “Some is shifting to the US,” ING’s Western Europe & US head noted, a trend that may partly explain the “very, very weak” Q3 2016 UK transaction volumes reported to conference by Real Capital Analytics’ Tom Leahy. Natixis’s head of real estate finance, Arnaud Heck, said “the clear request” of investors in his debt funds “was to put the pen down (on the UK),” because of perceived refinancing risk as well as currency risk.
For lenders operating outside the UK Brexit was less of an issue, if it was one at all. “It’s a UK problem,” declared Michael Morgenroth, CEO of Caerus who runs debt funds which lend stretch senior to borrowers in Germany. Highlighting the differences between the continental European market and the UK, and levels of capital flows since the Brexit vote, Shields said: “Europe is completely different. It is awash with liquidity.” Noting that “different parts of Europe and different sectors within markets are at different stages of the cycle,” Starwood’s MacPherson, said that the alternative lender has eased off on writing loans in the London market, with banks refinancing its London loans from 2013-2014. “That’s how it should work. We wrote transitional loans,” MacPherson said.
Lending to transitional properties will shift geographically, he added: “Perhaps somewhere like Madrid will be where the transitional play works best (next),” he said.
Syndication still active
The syndication market has been affected by the lower volume of deals this year, especially in the UK and Germany as Jean-Maurice Elkouby, managing director at ING Real Estate Finance, explained. “Clearly, the year starting with concerns about China spooked a lot of people, and then the referendum had us waiting. Now there’s a bit of a catch up effect both in the UK and on the continent. The dice has already rolled and we’re in Q4 but it will still be a reasonably good year.”
Agnes Decourcelle, director in real estate loan syndication at Société Générale, said pricing volatility – which makes syndication more challenging – varied considerably in different countries. In the UK, pricing for prime London deals reached a trough of 120 bps or even less by mid 2015, only to rise at the end of the year to about 150 bps. “So 150 was the new 120,” Elkouby said. “The effect of Brexit is probably another 25 bps, so now 175 bps is the new 150.”
A tax introduced in February on Polish banks is showing through in a two-tier market for pricing there. Italy and Spain saw some compression in H1 2016, which “seems to be stabilising” Decourcelle said. She added: “In France and Germany, pricing is still very competitive…if you compare a prime office building in the centre of Paris with one in London, assuming moderate leverage, there could be 70 bps difference.”
German bankers “are fighting for deals to underwrite” according to Berlin Hyp’s head of real estate finance Assem El Alami, describing how his bank has focused in its domestic lending on areas it knows well such as multifamily and logistics. It is in Germany that the prospect that lenders could still lose their heads seems possible, with Munchener Hypothekenbank’s Jan Peter Annecke worried that banks have been funding lower-quality properties and jettisoning covenants and amortisation for borrowers in order to win business. If market risk doesn’t make them cautious, they have Basel IV and the prospect of IRB standard rating models to worry about. “We can’t anticipate the full picture of Basel IV,” El Alami said. “It’s going to have a very, very big influence, especially on banks which focus on an internal ratings approach,” Deutsche Hypo’s Thomas Staats summed up.
Non-bank lenders gain ground
When non-banks entered Europe’s property finance market in 2010, they were viewed by banks and borrowers with a degree of scepticism. The cycle has yet to run its course, so these alternative lenders are yet to prove that they will stick around long enough to refinance their original crop of loans against a backdrop of changed market conditions, as relationship-oriented bankers pride themselves on doing.
Yet, the range of deals banks want to finance has narrowed further this year which is a trend that looks unlikely to reverse, while non-bank lenders argue that they have enough of a track record now to show they are long-term fixtures of the market. “Debt funds like us have gone through several capital raises, so we are established,” Dan Pottorff of LaSalle Investment Management said during one panel discussion. “Investors are a lot more comfortable with that product.”
One who agreed was Clearbell Capital’s Rob Mills. “We’ve been nervous about whether they will still be here (in future),” he said. “What has moved on is that we have seen a number of debt funds that are matching our own model of repeat capital raising. And as those funds become more established that issue is dissipating. They can be very nimble, if you fit their areas.”
At the same time, institutional appetite to invest in real estate debt is rising according to speakers such as Natixis’s Arnaud Heck and Caerus’s Michael Morgenroth. “There’s no asset class under Solvency 2 that offers a higher return than real estate debt’” Caerus’s CEO said.
In the UK, margins have gone up by 25-50bps — although they have come back down slightly from an immediate post-Brexit spike — and there’s 5 percent off the leverage available from banks. Development finance is much harder to get and speculative development finance is very hard
Banks are being cautious after two strong years in 2014/15 and after Brexit
Margins for prime London lending bottomed at around 120 bps last year, then went up to 150 bps. Since Brexit, “175 bps is the new 150”
Lack of visibility on UK property values meant the UK syndication market paused after Brexit. But it seems to be picking up in Q4 16
In the UK, non-bank lenders are taking up some of the banking slack; debt funds at the forum said they will lend up to 75 percent LTV
Germany is a different picture and pricing has remained stable — and cheap — because of continuing fierce competition to finance core deals
But…..IRB standard rating models and Basel IV are looming in continental Europe, which will cause debt pricing to rise. It is vexing German banks
German pfandbrief bank Munchener Hypo said it planned to restart lending in the US joining others, like pbb Deutsche Pfandbriefbank, which are also looking over the pond for profitable business
Japanese banks have gone from the UK syndication market which may be a sign of the London office market being quiet, as they were mainly taking participations in London deals. Transaction volumes in the UK capital fell to £2 billion in Q3 2016 according to RCA, £300 million of which was Wells Fargo’s purchase of a City building for its new HQ
For the first time since the financial crisis, Spanish banks are looking for lending deals outside their own country
Greece will offer NPL opportunities next year as buyer and seller price expectations converge
Polled on Brexit, the Forum audience clearly saw potential negative effects. Delegates felt it hasn’t had a huge impact — yet: 49 percent said its effects had been negligible so far and 47 percent that it had pulled the market ‘slightly down’. However, 79 percent said it had damaged the UK economy’s prospects
There is early evidence of international capital shifting from Europe — especially from the UK — to the US, according to Real Capital Analytics
One prediction from CBRE’s head of EMEA research, Neil Blake was that the UK government wouldn’t invoke Article 50 triggering Brexit until late 2017, after key Dutch, French and German elections. On 2 October, UK prime minister Theresa May announced it will be triggered by next March