Economic stagnation elsewhere makes Germany best bet for bargains, reports Lauren Parr
Germany is a favourite market for opportunistic investors, which have set aside a defined pool of capital for investments in distressed property there. As Phillip Burns, chief executive of Corestate Capital, says: “When it comes to a stressed or distressed deal, you want that to be in a stable, robust economy and Germany is one of the only places in Europe that offers that today.”
From direct properties and asset management mandates to co-investments and non-performing loan purchases, German opportunities are piling up, their sources including open-ended funds, banks, securitisations and developers.
There are both distressed assets and distressed sellers – and the two things are not necessarily the same. “We’re interested in prime, core assets being sold by distressed sellers as opposed to distressed assets themselves,” notes Ronald Dickerman, president of Madison International, for example.
He adds: “Economic stagnation in Europe means there is a lot of caution when it comes to investing. For example, many investors we see are not so crazy about buying a 15% vacant office building. Now we’re seeing prime real estate yields expand in Europe, people are questioning whether pricing reflects current risk, given what we know is happening in Europe now.”
German housing has allure
This is increasing Germany’s allure and one sector investors have increasingly been targeting is residential property. Portfolios of rented multi-family housing have become expensive since more opportunistic buyers started to compete with institutional investors, attracted by the asset class’s record or matching inflation and lenders’ continued willingness to offer debt secured against it.
German residential investment volumes hit €6.13bn in the first half of 2012, according to Savills, and are on track to reach €10bn by the end of the year – the highest volume since the market peaked five years ago.
The increase is partly due to the fact that €8.8bn of residential debt is due to be refinanced this year and next, and partly because state-owned landesbanks are being forced to sell their residential assets.
“Mainly we’re talking about privatisation, partly triggered by German landesbanks, which needed to be subsidised by the German state and have been told to sell portfolios,” says Tim Brückner, executive director at Corpus Sireo.
Landesbank Baden Wurtenberg raised €1.4bn by selling a 21,000-home portfolio; state-owned TLG, which owns 11,500 homes in eastern Germany, is set to be privatised; and BayernLB’s GBW property subsidiary is selling 33,000 homes (see pp19-20).
Private borrowers offload assets
Two of the largest sales this year were by distressed private borrowers: Cerberus won the Speymill portfolio (see panel, right) while Deutsche Wohnen clinched the 23,500- asset BauBeCon portfolio. Barclays sold BauBeCon by exercising a call option over borrowers RREEF and Pirelli’s Prelios after successive breaches of loan-to-value covenants and a drop in the properties’ value.
Some smaller distressed residential portfolios have been marketed, but most of those that are for sale or coming to the market, like one owned by the Landesbank of Bavaria, are not distressed.
With return expectations becoming harder to achieve at today’s prices, “investors are taking a longer look at which route to take”, says Brückner.
BayernLB director Gustav Kirschner says opportunistic investors are pursuing portfolios with high vacancy rates and a backlog of maintenance work.
Activum, the German opportunity fund manager founded by former Cerberus partner Saul Goldstein, is redeveloping residential property in Berlin that it acquired from an overseas developer and another insolvent scheme that it bought from the court. Peakside also has exposure to Berlin housing, having acquired one of its two developments there from an Irish developer that wasn’t able to inject equity.
Compared with German housing, which usually has very long leases, commercial offices are under more severe pressure in terms of their lease profile. The sector represents the majority of the €27bn-worth of European properties that closed and liquidating German open-ended funds have to sell over the next five years, most of which are in France and Germany.
The majority stake in the Frankfurt Trianon office and residential complex Madison International recently bought came from Morgan Stanley’s liquidating P2 Value fund, for example.
Some 11 out of just over 40 German open-ended funds are being wound down, including four of the biggest: AXA ImmoSe-lect, CS Euroreal, KanAm GrundInvest and SEB ImmoInvest, with €18.8bn alone. It’s a major acquisition opportunity – particularly for anyone looking to enter the German office market. The funds’ assets are mixed: some are in good locations and offer long-dated income, but there are also plenty of partially vacant buildings.
Prices must fall
Prices need to fall if funds are to dispose of all these assets, sources say. The liquidation process will help facilitate this, as it lifts the restraint over the level at which funds can sell; after the first year, a 5% discount is per-mitted, rising to 10% after year two.
The pressure on open-ended funds to sell assets could be increased by regulation coming into force next January, which will require funds to lower their loan-to-value ratios from 50% to 30% by the start of 2014.
Opportunities to buy distressed assets, or buy from distressed vendors, could come from parts of the retail sector, especially assets in the former East Germany and properties with discount retailing tenants.
By and large, retail remains a popular asset class, with core and core-plus retail investments heavily sought after and hard to find. A shortage of core product contrib-uted to a 47% year-on-year fall in retail investment in the first half of 2012, down to €3.2bn, according to CBRE’s figures.
“Even where the product is not perfect, investors are paying top dollar to step into these situations,” says Boris Schran, founding partner and head of acquisitions at Peakside Capital. This supply bottleneck is making international buyers look at secondary locations. “If you do see distress, there will probably be a severe defect in the asset,” Schran says.
Jan Dirk Poppinga, CBRE’s head of retail investment, Germany, says prices are falling for assets where locations are weak and leases close to expiry. Some international banks are now looking for an exit from such deals. They financed more supermarket portfolios, retail parks and retail warehouses than German banks, which focused on top-quality and were less active in retail.
In many cases, “banks must now find a exit solution. Sometimes the only way is insolvency proceedings,” says Poppinga something he expects to see more of. Axel Froese, an investment manager with Cordea Savills, says: “We’re interested in going after properties where banks view their exposure critically if a portfolio has a remaining lease maturity of below six or seven years. They don’t know whether there is a risk of the tenants moving or only paying half the rent.”
Overseas investors as well as lenders are exiting their investments. “We’re looking for distress where we can add value,” says Stuart Reid, head of Rockspring’s German operation. “A lot of that is coming from sponsors in places like Ireland, Spain and the Nordic countries, who entered Germany in the last wave in 2005-07, didn’t have a strong local presence or market knowledge and made poor investments that are now facing problems. In many cases, these investors have already gone and banks are left dealing with these investments.”
Banks are also grappling with not-so-badly performing properties where loans are approaching maturity which they don’t want to refinance, but don’t necessarily want to accelerate or enforce.
Activum founder Saul Goldstein sees this as an opening to provide finance. “We’re seeing interesting opportunities in mezzanine lending,” he says. “We’re filling the gap where we would otherwise be an equity buyer.” Activum recently provided financing equal to 20% of the cost of a retail and office project in Frankfurt and has also bought notes from lenders at a discount and then executed a debt-for- equity swap to take control of the project.
Many of the investors looking at distressed opportunities in Europe are US-style opportunity funds hunting for loan-to-own deals, but in Europe they have not seen the same volume of loans offered for sale as they are seeing in the US.
Banks prepare to go to auction
A number of German balance-sheet lenders are believed to be creating shortlists of potential buyers so that when they’re in a position to sell, small auctions may take place.
PricewaterhouseCoopers estimates that the volume of total non-performing real estate loans on German banks’ books at the end of 2011 was €196bn, down from €214bn at the end of the previous year.
However, compared with overseas banks, German banks have generally been relatively slow to offload non-performing loans. So far, there have been a few trades of between €100m-150m from banks that are dealing with peripheral, rather than core, exposure to bad property loans.
“Assets are only coming to the market because of an immediate liquidity shortfall; banks are still slow to clean up their books, and events are mostly driven by lease or cash-flow maturity on the underlying assets, rather than loan maturities,” says Schran.
Loan sales will take more time “because German banks’ balance sheet strength is not fundamentally right and regulation makes it even more difficult for banks to sell loans below book value,” Brückner adds. “I expect that over the next 18-24 months, one by one banks might be able to offset write-downs on mid-sized transactions, as it won’t any longer be seen as such a political decision.”
While the pace of loan disposals has disappointed many would-be investors, acknowledges Colin Fleury, head of secured credit at Henderson, “non-performing consumer loans seem to be an area of focus; banks are trying to shift those, given the higher cost of holding them”.
Most market watchers concur that a wave of big distressed loan portfolio sales is unlikely. “I’m pessimistic that we’re going to see a wave of big portfolio deals, as certain banks are government-backed and as long as cheap refinancing is available, they are not under any time pressure,” says Schran. “Other institutions simply can’t afford the necessary write-offs of certain loans.”
Cerberus bites off big chunk of Hypo bad bank’s assets
Cerberus has been an active buyer of distressed assets in Germany. In July, the US private equity firm picked up one of the first significant packages to be sold by Hypo Real Estate’s bad bank: 47 retail assets comprising construction sites, small regional shopping centres in North Rhine-Westphalia and units let to Aldi and Rewe.
The original borrower, JER Partners’ European fund, paid around €100m for the assets and Cerberus acquired them for less than the value of Hypo’s original financing. JER Partners was a casualty of the downturn and since earlier this year its European assets have been managed for investors by LaSalle Investment Management.
HRE’s bad bank, FMS Wertmanagement, reduced its commercial property portfolio by nearly €7bn last year through some sales and loan repayments.
In May, Cerberus bought bankrupt Speymill Deutsche Immobilien Company’s 22,000-strong Halk multi-family housing portfolio.
The complex deal involved restructuring SDIC’s €985m debt pile with its lenders – Dutch NIBC Bank and German landesbanks Nord LB and HSH Nordbank and resetting the loans at a market-rate margin of 250 basis points. SDIC defaulted on the loans in 2010 when the portfolio’s vacancy rate was 13.5%; Cerberus beat Goldman Sachs, Blackstone and Morgan Stanley to acquire the assets.
Cerberus is making an undisclosed investment, in the form of subordinated debt and equity, which will be used to pay down debt and provide capital expenditure, and some individual assets will be sold to private investors.
Cerberus senior managing director Lee Millstein said at the time: “The banks benefit from this deal by having a large portfolio of non-performing loans converted to performing loans, while stakeholders benefit from Cerberus injecting new capital for improvements and leading the execution of a turn-around of the assets.”
Ernst & Young, receiver to SDIC, also agreed the sale of a sub-portfolio that had been securitised in the TOR CMBS, issued by NIBC Bank.
Benson Elliott bought most of the sub-portfolio, with assets in strong locations in Berlin, Frankfurt, Munich and Cologne, out of receivership for its third fund.