Warning bells sounded over GFC-style leverage use

In a presentation at PERE Asia, the head of real estate at BPE Asia questioned the use of leverage by his competitors, suggesting similarities with pre-crisis behaviors.

Delegates at PERE Asia, hosted by our sister title in Hong Kong, were cautioned on the uses of gearing by private real estate managers that carry similar hallmarks to debt use in the years leading to the global financial crisis a decade ago.

In a keynote presentation by Mark Fogle, managing director and head of real estate at Hong Kong-based private equity firm BPE Asia, the conference’s audience heard how some strategies in the region are predicated on leverage levels reaching 90 percent loan-to-value, a realm reached widely during the run-up to the crisis.

Fogle blamed a combination of high cap rates, managers sitting on large quantities of dry powder, or uncalled equity – some simultaneously also fundraising again while investor appetite for real estate continues to hold – and relatively low borrowing costs for creeping equity to debt ratios.

“The average trade for office in Asia is currently $389 million,” he illustrated. “Through 60 percent to 80 percent leverage, equity required is $75 million to $150 million. Managers have got to do a lot of deals to place capital. That is forcing funds to move up the risk curve.”

He called it “bubble investing” – acquisitions made in a period of peak valuations that occurs pre-correction. “Core funds too are also taken on higher risk – either with more leverage or moving to secondary cities.”

He said another common occurrence was managers borrowing senior debt at up to 60 percent loan to value, then adding mezzanine finance to bring the total debt on a deal to the 90 percent mark.

Challenging the audience, he asked: “If you look at a deal and the way to do it is with high leverage, is it still real estate?”

He urged investors to distinguish between managers which underwrite deals the same, regardless of whether they are struck for core or opportunistic strategies, using only leverage levels to determine the appropriate strategy, and those which had underlying expertise in the asset class to drive value.

On the sidelines of the conference, one Asia-based consultant told PERE: “People certainly are feeling urged to complete fundraising, making hay while the sun shines.” He added that he agreed with Fogle for the most part, noting he had come across managers raising the senior leverage levels to 75 percent with use of subscription lines and other forms of financing taking loan ratios higher than the debt levels originally set. Oftentimes, he said, financing is justified depending on its duration: “For example, short-term borrowing of less than 180 days is sometimes not declared even as leverage. It is always worth questioning the duration.”

BPE Asia was one of a handful of Asia-focused managers to raise $1 billion or more for its latest vehicle, when it closed on BPEA Real Estate Fund II in the fall of last year. 

PERE Asia week culminates with a day on property technology tomorrow.

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