9At this stage of the real estate cycle, investors are looking for new angles from which to tackle the market. For an increasing number, the hunt for returns means exploring Continental Europe, in cases deploying capital in some countries for the first time.
While the availability of debt was constrained across several European markets until relatively recently, a growing number of lenders are willing to provide finance as they, like their borrowers, seek yield in unfamiliar territories.
First Growth Real Estate, an independent advisory firm established in 2010, specialises in advising those involved in debt situations, ranging from capital-sourcing, to restructuring and special servicing. The firm has offices in London, Paris and Milan and is planning to expand into Spain. Real Estate Capital discussed market conditions with co-founders Francesca Galante and Cyril de Romance.
Real Estate Capital: Is Brexit driving real estate capital into Continental Europe?
Francesca Galante: It’s a significant factor. The reduced appetite for the UK has contributed to a structural shift to continental markets such as France, Italy and Spain. We hear investors with euro- but also dollar-denominated funds say they want to reduce exposure to the UK and Europe gives them the opportunity to diversify. This also applies to the lenders. Some banks are shifting away from exposure to the risk of the UK.
REC: Where is the capital heading?
Cyril de Romance: France is back on investors’ radar and is a big beneficiary of Brexit outflows. That is also due to the positive sentiment created by the election of Macron and the economic growth story. We’re seeing a revival of the office letting market in Paris/Greater Paris, for example. There is a lot of capital at play in France, both equity and debt. In the financing space, senior leverage is typically capped at 65 percent, but there is enough liquidity that borrowers need to look for the best terms as well as higher leverage if required through whole loans or subordinated financing. That creates an opportunity for advisors to take on that process for those unfamiliar with the market, or those that don’t have the resources to dedicate to looking for finance.
REC: What is driving the Southern European markets?
FG: There’s a lot of foreign investment. Last year, it accounted for 76 percent of Italy’s market and 61 percent of Spain’s, compared with 32 percent in France and 48 percent in Germany. In Italy, investor appetite is sustained by the excess of liquidity chasing European real estate in a late-cycle market. Italy had its best year of direct asset investment in 2017. There was also a high volume of non-performing loan sales, which drove investment. Around €65 billion of legacy debt changed hands.
CdR: In Spain, foreign investors are drawn by strong underlying real estate trends, including rental growth and yield compression. The market is driven by a solid economic recovery, with GDP at 3.1 percent last year, which outpaced most of Europe. The volume of non-performing loan sales was also significant, with €51 billion trading. That’s why we are aiming to establish an office in Madrid.
REC: Are Southern European real estate debt markets liquid?
FG: As with equity, liquidity for real estate lending is significantly above the historic average, reaching levels seen pre GFC. Foreign lenders have increased exposure as they search for yield. Margins are at their lowest ever post GFC in core markets such as Germany and France, so lenders are looking elsewhere for higher-margin opportunities. Pricing widened in the UK after the EU referendum, but lenders are cautious until there is more clarity around the conditions of Brexit. Margins have fallen in Italy and Spain for prime property and reputable sponsors, but there remains a premium to more established markets. For prime lending deals at 50 percent loan-to-value, lenders can expect 20 to 30 basis points more margin in Italy than in France.
REC: Are domestic banks in Southern Europe back in the market?
FG: The Italian banking industry is emerging from a long period of distress, with ongoing deleveraging drastically reducing tail risk. Banks have, in parallel, increased new lending. Local banks are increasingly becoming as active as their foreign counterparts when it comes to the main cities but are arguably more active in secondary cities where their local presence gives them an edge over competitors.
CdR: In Spain, domestic lenders have also come back as their balance sheets are repaired and the lending opportunities increase with the high volume of investment transactions. They are getting back into development financing, although they remain reluctant to fund land purchases, as many still have land deals on their balance sheets.
REC: Is Italy as challenging a market as critics suggest?
FG: The new coalition government has impacted confidence. Lenders in many circumstances have tried to reprice following the spike in Italian sovereign bond debt yields. The government’s stance on NPLs is also unknown. However, Italy is not as much of a challenge as some say. Enforcement has become easier since the previous government’s reforms in 2016. We took on the work-out of the former Eurohypo’s Italian loan book and were able to successfully enforce securities, including in southern regions, and/or implement in restructurings new Patto Marciano security packages, which are designed to allow lenders to bypass court proceedings in the case of a loan default.
REC: Is Southern European bank deleveraging a future opportunity?
CdR: For investors with limited direct investment reach, it represents an opportunity to invest in scale in these markets. For lenders, improvements in profitability derived from deleveraging allow banks to support economic growth. For advisors, the increase in non-performing loan sales fuels demand for complex debt servicing skills. While many large NPL investors have acquired loan servicing platforms as a mean of getting access to expertise and knowledge in markets such as Italy or Spain, numerous smaller investors are relying on independent and local special servicing platforms, which are a scarce resource.
REC: What do you consider Europe’s emerging real estate debt markets?
FG: Although Greece is still at an early stage of the deleveraging process, it is a significant opportunity as there are €100 billion of NPLs. The progressive economic recovery along with the implementation of structural reforms are strengthening the interest of investors. However, investors are therefore underwriting very low pricings to achieve high returns in line with the associated high risk.
CdR: In Portugal, some Spanish and local banks are currently active but are limiting their lending to senior debt, leaving room for debt funds or more flexible lenders to finance higher-risk deals involving value-add properties or acquisition of land for developments.
REC: Why are there relatively few real estate debt advisors in the Continental European market?
FG: The role of a fully-fledged, client-focused, financially sophisticated debt advisor is still relatively nascent. As sponsors find it time-consuming for their teams or difficult to raise new financings, they gradually turn to outsourcing such functions. The need for advice differs across markets; France is a real estate transaction-driven market, while Italy is more focused towards NPL activity, and Spain is a mix of both.
REC: In a market with little history of debt advisory, how do you find clients?
FG: Relentless market scouting is essential. We identify potential clients where we feel there could be a need, proactively research the situation and present our ideas. We also use our industry contacts. Repeat business is crucial; each client we have had has come back to us for an additional mandate. We were investors and lenders across the capital stack in previous jobs, so we are like-minded with our clients. It’s also crucial to literally speak the same language as them.
• Project Borromini: The former Eurohypo Italian real estate loan residual portfolio standing at circa €300 million was sold to Deutsche Bank and Davidson Kempner supported by First Growth. First Growth’s advisory and special servicing mandate began in 2015 when the portfolio balance stood at €1.1 billion.
• Kaufman & Broad headquarters, La Défense: Advised on the purchase and development financing of the La Défense office building for Eurazeo. The circa €130 million finance came from a consortium of French banks.
• Four Points, Milan: Advised on the purchase and development financing of Aina’s acquisition. UBI and BPM provided circa €30 million debt.
• Securitisation (ongoing): Providing assistance to an Italian SGR to restructure for a fund indebtedness in a securitisation conduit (circa €150 million).
This article was sponsored by First Growth Real Estate.