FEATURE: Bridging the lending gulf

New players enter the European real estate finance market as some established lenders pare back. PERE Magazine, April 2011 issue

It used to be that the overstretched finance professional at a real estate fund manager could scroll through a list of trusted bank lending contacts, ping an email and wait for the term sheet to duly arrive for that refinancing or new acquisition.

These days, however, those contacts are just as likely to be either in workout mode, working for different companies or out of work altogether. Meanwhile, those that are still at the same desk and are able to lend are very likely to have much stricter funding parameters.

To be sure, the European real estate finance industry has changed incredibly since the onset of the financial crisis. Established lenders, such as the various German banks, have dramatically scaled back their activities, creating a void for newer players such as debt funds and insurance companies to opportunistically step in.

In February, Richard Ellis provided a stark reminder of just how much Europe’s lending capacity has been reduced when it published a report suggesting that 38 lenders with exposure to the UK had closed to new lending. Furthermore, 70 percent of those that had retrenched were European banks, building societies and investment banks – the traditional providers of debt to the industry.

Philip Cropper, managing director and head of real estate finance at Richard Ellis, said certain banks, such as those from Germany, are definitely quieter now, making it tougher for borrowers. “It is much more difficult to get debt,” he noted. “One has to hunt out the right debt from the right source.”

One of those right sources might be alternative lenders, such as insurance companies. The two insurers most often cited today as active sources of finance in Europe are AXA Real Estate and MetLife. Indeed, MetLife recently provided a £107 million loan to refinance 17 Columbus Courtyard in Canary Wharf, London, while AXA Real Estate wants to commit £1.2 billion to provide debt financing to commercial real estate and has raised £300 million for its first dedicated senior debt fund.

Still, no one thinks such alternative lenders will bridge the gap in the €450 billion that needs to be refinanced in European real estate between now and 2013, let alone cover demand for new loans. That is why there is some disappointment that the commercial mortgage-backed securities market has yet to return, the way it has started to recover in the US.

According to Cropper, the issue with CMBS is that potential investors are still very wary of such transactions. “Noteholders are going to scrutinise everything, and the pre-sale process will be much more structured to meet demand in the marketplace,” he said.

Nevertheless, any securitisation activity is better than none. In the meantime, there are always those alternative sources of capital to consider.

A few hungry men
Savills revealed its list of the top lenders in UK commercial real estate, including several new entrants

In its annual list of the most active property lenders, international real estate advisor Savills said the UK commercial real estate market has witnessed the arrival of a bunch of new entrants. Among the “most active bigger-ticket lenders” – those that actually achieved total lending of at least £75 million (€86 million; $122 million) over the past six months, with typical loan sizes of more than £20 million – were Deka Bank, Deutsche Hypo, HSBC, ING Real Estate Finance, Landesbank Baden-Wüerttemberg, Société Générale and insurer MetLife, all of which Savills tagged as strong emerging lenders.

“The new names appearing in the market are encouraging, in particular those non-traditional banks such as insurance companies,” said William Newsom, UK head of valuation at Savills. “For the most part, however, they remain on the periphery of the market and collectively they are not making up for the reduced activities of existing players.”

Indeed, the impact of Basel III, along with banks’ continued caution, the expected wave of refinancing and the increased cost of capital, has led to banks such as DG Hyp and West Immo exiting the market in the past six months, Savills noted. Furthermore, Basel III, which requires banks to hold higher capital reserves against its loans, may cause additional banks to reconsider or reduce their lending activities ahead of its January 2013 implementation.

Imported finance
Alternative capital sources step in where banks fear to tread

Last month, a Chicago-based private equity real estate firm proved it was willing to step in where traditional UK lenders are largely unwilling to tread: development financing.

Over the past few months, LaSalle Investment Management has financed almost £100 million (€114 million; $163 million) in development projects in Britain. The latest example arrived in March when it provided £40 million to local property developer Brookgate to develop CB1, three student housing properties at Anglia Ruskin University in Cambridge.

According to John Yeend, the director at LaSalle who led the deal, Brookgate is a company that was formed in 2009 in conjunction with Lloyds Banking Group but found itself in need of additional funding. “There is patent unwillingness from lenders to put more equity into developments, even if they already are in the vehicle and there will be profit in the end,” he said. “This is where we come in, to fill the finance gap.”

The student housing project is being funded by a pension fund client via a separate account managed by LaSalle. The way the deal is structured, the pension fund client has agreed to acquire the land and then make staged payments throughout the development phases to fund construction, with a balance of payment at the end of the project.

“It is traditional institutional funding that went out of vogue when debt financing was much cheaper and readily available,” Yeend noted, adding that these kinds of deals are complicated, time-consuming and require a good deal of effort. In the end, however, LaSalle and its client were left with a yield of around 7 percent and a lease agreement with rent increases linked to inflation.

In fact, the Brookgate deal is the second transaction Yeend personally has been involved with on behalf of the pension fund client in the past few months. In the other instance, the client funded the development of a Tesco supermarket, a cinema and some speculative restaurant units in Lancashire in the north of England for around £48 million.

At this stage, Yeend does not see any change in terms of traditional banks beginning to lend against UK development. Luckily, for the moment, it seems that alternative sources of capital are happy to oblige.

Iceland’s meltdown
Three banks, which expanded into real estate financing prior to the crisis, now face the challenge of selling their assets

Prior to the credit crunch, there were five major banking groups in Iceland, three of which went on an amazing international expansion trail. By some estimations, the combined balance sheet of Glitnir, Kaupthing and Landsbanki grew to become more than 10 times larger than Iceland’s gross domestic product in the span of a few short years, amassing around €50 billion of foreign debt by 2008. 

The three Icelandic banks grew by acquiring positions in other European and Scandinavian banks, as well as organic growth. They expanded abroad primarily through corporate and investment banking services, as well as private banking and asset management.

As part of that expansion, the three banks became active in real estate financing. Ari Danielsson, managing director of Reviva Capital, a Luxembourg-based business that is restructuring and working out distressed asset portfolios for some of the Icelandic banks, said they generally focused on providing junior and mezzanine loans. However, the banks also gained exposure to European real estate by funding corporate real estate investors via their Luxembourg subsidiaries.

In 2008, when the banks got caught in the credit crunch, Iceland’s government allowed the domestic financial authority to take over the failing banks. However, rather than be separated into good bank and bad bank structures like other banks in Europe, they were divided into domestic and foreign bank holdings. In the case of Glitnir’s subsidiary in Luxembourg, it was left with around €1 billion of real estate-related assets on its balance sheet, and it is thought the other two banks have similar amounts.

Since those dark days, quite a lot of progress has been made working out the core balance sheet assets of the banks. “We are in the mode of continuing to work on these assets and preparing them for eventual divestment,” Danielsson said.

So what is the angle for opportunity funds? “There is going to be a significant refinancing need in the next two or three years, and it is going to be non-bank players stepping in,” Danielsson noted. “In many of our situations, the new capital is being injected by an investor that has gone from equity to lending. That trend will continue and increase dramatically over the next few years.”