GERMANY DISTILLED Five real estate professionals analyse the opportunities in Continental Europe’s largest market Sponsors: CBRE Corestate Capital MGPA Reviva Capital Union Investment PERE Magazine October 2012 issue

Before the wave, the swell


Mid-sized managers are cherry-picking property deals in Germany in
anticipation that long-expected sell-offs by the country’s banks are
drawing near. Robin Marriott

In August, Pacific Investment Management Company (PIMCO) bought a €238 million Lehman Brothers real estate debt portfolio from the Bundesbank. That transaction marked the second time this year that the fixed-income investment behemoth had acquired a portfolio from Germany’s central bank. The first time arrived at the end of March, when the Newport Beach, California-based firm bought the €1.4 billion Diversity Funding CMBS related to Lehman’s securitisation of the UK’s Northern Rock commercial real estate loan portfolio.

Deals like this certainly are eye-catching and come on the heels of such 2011 transactions as Arminius Advisors buying a controlling majority of 14 special-purpose entities from Eurocastle Investment for €984 million and the purchase by Colony Capital of nonperforming loans from four German banks: Eurohypo, Landesbank Hessen-Thüringen (Helaba), Berlin Hyp and Archon Capital Bank. Nonetheless, any suggestion that Germany is a large ‘distressed’ market for opportunistic real estate firms isn’t the whole story.

Closer to the truth, Germany is a country for basking sharks, where one or two large transactions tend to get done every year. Below the large-bracket deals, some opportunity funds guesstimate they are seeing perhaps five to 10 very good deals per year.    

Germany, therefore, still doesn’t seem to be a notable distressed market even though four years have elapsed since the financial melee of 2008. As a result, investors from both outside the country and within it say they like Germany as a real estate market because of its stability.

Adjusting expectations

Dirk Richolt, managing director of capital markets at CBRE in Germany, says the biggest struggle facing the private equity industry is that the return model saying funds need to deliver 20 percent-plus annual returns needs to be re-calibrated on the back of the current low-leverage environment. That said, there are a number of examples of foreign investors seeking income and yield from German real estate.

One example is the sale of Maximilianhöfe, a mixed-use property in Munich, for an amount reported to be between €240 million and €300 million. CBRE brokered the deal for Avestus Capital Partners, which sold the asset to Pembroke Real Estate on behalf of Fidelity Investments in May.

However, the most-often cited examples exemplifying the trend are TIAA-CREF’s purchase of the Perlacher Einkaufsparadies shopping centre in Munich from RREEF last December and the 50 percent stake in the Centro Oberhausen centre near Dusseldorf  for a reported €270 million by the Canada Pension Plan Investment Board, also last year.

“These are just examples where we do see competition coming from outside,” says Christoph Schumacher, managing director at Union Investment, the German bank-backed asset manager with €20 billion in property around the world. “Prices are very competitive,” he adds, noting that his firm sees competition especially in the retail and office markets.

The obvious cause of this outside interest is Germany’s relatively stable economic outlook compared to the rest of Europe. It is the same reason why investors also like the Nordic countries of Sweden, Denmark, Finland and Norway.

Union Investment, which manages open-ended funds for retail and institutional investors, can itself provide an example of demand for Germany’s real estate. Indeed, one of the firm’s big moves is the preparation of an open-ended property fund primarily for smaller German institutional investors, reveals Schumacher, who is responsible for the firm’s €3.3 billion institutional real estate business, including open-ended property funds, special funds and focused real estate funds. The message of these sophisticated investors is clear, he says: “They want stability – German stability.”

MGPA’s European chief executive Laurent Luccioni supposes that, for every euro being invested in German real estate, just 10 cents goes to opportunistic deals. The rest goes to core-plus and value-added strategies. “It has been this way for a while now,” he says. “It is true that this has been a much more core-plus, value-added market than a truly opportunistic one.”

Still, this shouldn’t be the final word. If one examines the economic history of Germany, Luccioni believes there is little reason to suppose that the country should always be more stable than any other economy. He acknowledges that it is more competitive right now, but things can always change quite quickly.

Low-hanging fruit

Furthermore, if Germany were only for stable income-driven buyers, there wouldn’t be any opportunistic buyers operating in the country. That of course, isn’t the case.

MGPA has been operating in the country for a number of years. In March, it bought its third retail warehouse portfolio, comprising 11 properties with re-letting opportunities mainly in western Germany. Likewise, Corestate Capital has been scouting deals for six years since being established in 2006 as a value-added and opportunistic firm. Lately, the firm has been entering into club and joint venture transactions.

Ralph Winter, Corestate’s founder, agrees with Luccioni that the task is about finding active special situations in the debt structure or leases that the owner or lender cannot ignore because the asset is losing value very quickly. “It is about cherry picking,” he says.

Corestate is focusing on ‘destabilised’ situations, and Winter argues that higher returns are possible. “This is a good environment in my opinion,” he adds.

In March, for example, Corestate bought a €50 million-plus distressed portfolio comprising 20 traditional High Street assets in urban locations such as Aachen, Hamburg, Duisburg and Potsdam. A foreign investor originally bought the portfolio in 2006, but the management seems to have been wayward since then. Vacancy in the portfolio increased to 30 percent and net rental income dropped significantly, putting the portfolio and the underlying financing into distress.

Marc Arand, a director at Luxembourg-based Reviva Capita, knows better than most about mismanaged German assets lurking with the portfolios of real estate borrowers and banks. His firm provides advisory services to clients about how best to work out and restructure distressed and non-core asset portfolios, as well as being a partner to private equity firms.

In fact, some 23 percent of the €1.5 billion in assets Reviva advises and manages for clients lie in Germany. Examples of mandates include a €50 million restructuring of a five-star hotel and structured divestments of more than €100 million of residential portfolios in the country.

“We are seeing assets that really need management or repositioning, but there is also another trend – banks need to reduce their balance sheets,” Arand says. “We expect much more volume will happen in 2013 and 2014.”

The bank conundrum

Arand’s argument is well grounded, but German banks are not doing very much at the moment. Very little is being put up for sale, and it is frustrating for private equity firms because they know it is there, just out of their grasp.
Most of the action seems to be coming from German state sellers. Indeed, there are some big state sells-offs coming to the market, including the sale of TLG Immobilien and TLG Wohnen and its 11,500 units by the Ministry of Finance, but they are not bank sales.

Arand says Reviva will continue to assist banks in shrinking their portfolios and is hopeful of picking up portfolio trades in association with private equity firms next year. One caveat he makes is that the banks in Germany have large workout departments, but he questions whether they are the “right people” to manage the assets.  
Beyond the staff, there are plenty of reasons why bank sales have not materialised to any great extent. Not least is a big difference between the price the banks want and the price buyers are willing to pay.

“The pressure is to rebuild balance sheets, not to build a bigger hole,” Luccioni quips. “The big problem is often the pricing. You can imagine what the banks are valuing it on their books and what it is really worth.”

Winter adds: “You see a lot of these banks are focusing on refinancing. Our latest research with the European Business School shows that write-offs of 20 percent to 30 percent will come very soon.”

CBRE’s Richolt foresees that private equity firms will not be allowed by the banks to make 20 percent-plus returns. “It will not come from a big portfolio discount,” he says.

That most bad banks can refinance themselves on government bond terms also goes some way to explaining their 10-year business plans. “No one is doing what the Americans are doing with the FDIC,” says Richolt.

This state of affairs might not last forever, though.  So long as banks don’t want to lose money by selling portfolios, the banks cannot free up capital. As long as they keep that mentality, there is no way they can grow. “It is coming to the point – no one knows when – when it is logical to say ‘I will cut some of my losses and free up capital to grow,’” argues Luccioni. “But to do that, you need stability and confidence with the economy.”

The open-ended option

Besides the banks, other large holders of real estate that should yield big sales are the German open-ended funds, many of which have been liquidated in the wake of the global financial crisis. Even here, says Schumacher, forces have contrived to prevent sales at large discounts.

In a remarkable story, the German government tried to step in and help the industry by altering the structure of open-ended funds. In order to protect funds from liquidity problems, new rules mean investors have to give 12 months’ notice before being allowed to redeem capital. There also is a 24-month holding period for new investors
Nevertheless, some investors have been spooked and liquidations are taking place. In May, for example, the Credit Suisse’s Euroreal fund, with €6 billion of assets, announced its liquidation. SEB Immoinvest, a €6.4 billion flagship fund managed by SEB Asset Management, also is liquidating.

According to rating agency Fitch, nearly 30 percent of all German open-ended real estate funds are now in liquidation mode, representing some €23 billion of assets. Still, both Credit Suisse and SEB have announced “orderly” liquidations over a five-year period, and there does not seem to be anything to force them to sell quickly.
“Even the open-ended funds have sufficient time to sell their assets,” says Schumacher. “We acquired two shopping centers in Germany and an office building in Luxemburg – core products that generally attract good prices – from funds in liquidation. But it will be quite difficult for the funds to put their distressed assets to market. We haven’t seen any successful portfolio deals yet.”

Considering the exit

When an opportunistic firm does spot a deal, it not just a question of making a simple valuation that presents a challenge. Unlike some buyers, such as the listed German real estate companies, private equity firms need to consider the exit upfront.

Corestate’s Winter makes the argument that German listed real estate companies have the advantage over opportunity funds in that they are not under the same pressure to prove who will buy the asset  after several years. “They can hold it on the balance sheets for decades. It is only a question of making the right valuation,” he says. “If you work in private equity, however, there will be a day when you have to sell the assets. I guess that is what is very challenging in many of these deals. You can own them and improve them, but who will buy them at the end of the day when banks are not financing them?” 

At least, Corestate has present experience of exits. Back in May, it sold a €100 million commercial and residential portfolio of 1,250 assets to two separate buyers – one a London-listed property company focused on Berlin and the other a closed-ended German fund. The portfolio had suffered from a significant maintenance backlog prior to Corestate’s takeover and needed two years of professional management to get them into better shape.

In their own way, all the firms represented at this year’s roundtable are cherry-picking opportunities, albeit in different ways. Some at the table like CBRE want good-quality assets to sell, and others want distressed assets to buy. Whether Germany ever becomes a full-fledged distressed real estate market, however, is still open for debate.


See you in court

At last, Germany is trying to improve the creditor’s position in insolvency proceedings, which could give banks better tools in dealing with their real estate problems.
For a long time now, German creditors have envied the UK’s insolvency laws, which make things relatively easy to gain control of matters. Soon, however, they may not need to be so envious if proposed legal changes pass into law.
In March, new amendments to Germany’s bankruptcy code came into force. Known as Erleichterung der Unternehmenssanierung, or the Act for Further Facilitation of the Reorganisation of Enterprises, the new amendments aim to tilt proceedings more towards the interest of creditors by giving them a greater influence over the identity of the preliminary insolvency administrator.

Dirk Richolt of CBRE explains that, before this law was passed, a bank was given an insolvency administrator by a court. If the bank had a favourite practitioner, it would not be possible to have him or her work on the insolvency. Today, that situation has changed.  

In addition, some formalities will no longer require shareholder approval and it will become harder for shareholders to challenge an insolvency plan. Furthermore, certain risks for lenders, where they involve themselves in debt for equity swaps, also will be mitigated.

The new development is a leap forward and should improve Germany’s insolvency law, allowing for the reorganisation of assets rather than liquidation. Indeed, CBRE is taking note of the change in the fresh law with interest.

“Before, banks by nature were passive,” Richolt says. “They couldn’t craft their own destiny, but this new law might give them some tools not dissimilar to what banks have in the UK.”
Although there has not been a single case yet, Marc Arand of Reviva Capital says banks already have looked at it. “It is a much better tool than before, and it will be used much more in the future. The problem is people are not used to it yet.”

Laurent Luccioni
Chief executive officer, Europe

Luccioni is responsible for the management of MGPA’s European operations, as well as the oversight of the day-to-day operations of all the MGPA Europe Fund portfolios. He has 16 years of experience in real estate development and finance in both Europe and the US and has been responsible for more than 20 investments representing in excess of $2.5 billion in gross asset value.

Marc Arand
Reviva Capital
Arand is a director at Reviva Capital, a Luxembourg-based advisory firm with around €1.5 billion under management via various mandates. He has more than 15 years of banking experience, initially specialising in large corporate lending transactions in the Benelux region for LB Lux, a subsidiary of Germany’s BayernLB, and later in leveraged buyout finance for various industries.

Christoph Schumacher
Managing director
Union Investment

Schumacher is a managing director at Union Investment, one of Europe’s biggest real estate investment managers, and is responsible for the firm’s €3.3 billion institutional real estate business. He joined the Hamburg-based firm from Generali Deutschland Group in March 2011 and currently handles fund structuring and client relations for the institutional unit.

Ralph Winter
Corestate Capital

Winter is the founder of private equity real estate firm Corestate Capital and chairman of the investment committee. Prior to starting the Zug-based company in 2006, he headed the real estate team of New York’s Cerberus Group, where he grew investment volume to more than €5 billion in residential and commercial real estate and nonperforming loans.

Dirk Richolt
Managing director of capital markets

Richolt is managing director and head of real estate finance for CBRE. He joined the Frankfurt office of the global real estate services firm in January 2009 and is responsible for refinancing, as well as acquisition and corporate finance advice, for real estate clients in Germany and Austria. Prior to CBRE, he worked at DekaBank as head of loan origination for its international business and later was responsible for the real estate investment banking business of Citigroup and Barclays Capital in Germany.


Open-ended problem
The German Ministry of Finance wants to prohibit the open-ended funds that had been so popular in the country prior to the financial crisis

The popularity of open-ended funds in Germany led to a plethora of vehicles being launched in the past decade, but the global financial crisis led to severe redemptions. Ever since, legislators in the country have been trying to create a new model, and their latest effort is perhaps the worst yet.

Germany’s Ministry of Finance has proposed placing a prohibition on the creation of new open-ended funds and property Specialfonds as part of the wide-ranging Alternative Investment Fund Managers directive. The proposal states that existing open-ended funds will be subject to a ‘grandfather clause’, which allows for the old rules to continue applying in those cases. However, new open-ended funds will not be allowed.

The predictable result has been that managers have inundated BaFin, the German financial services regulator, with grandfathering requests and fund launches. Union Investment is among those seeking to push through plans for a new open-ended product before any change in the law actually takes place.

“The entire industry is having a close look at the draft because it will not allow the launch of new open-ended real estate funds in Germany,” says Christoph Schumacher of Union Investment. He worries that new funds may look to structure outside of Germany – in Luxembourg or Ireland, for example – to circumvent what the German legislature wants.

Due to the level of opposition not just from real estate managers, but from investors and opposition politicians to the government, some believe the proposal will fizzle out before it comes into force, which likely would occur after November. As things stand now, however, it is very much alive.


A bridge to Asia

A KAG vehicle for institutional investors has attracted €85 million to invest in Asia

For some, Germany is a sweet spot to raise institutional capital. MGPA, for instance, recently announced that it had raised €85 million from German investors for a fund targeting core-plus opportunities in Asia.

MGPA says it spotted an opportunity last year when it noticed demand among Germany’s institutional investor base to diversify outside their home country and gain exposure for ‘less risky’ assets. In order to tap limited partners, the firm decided to employ the services of Universal-Investment, which already had the platform to create Kapitalanlagegesellschaft (KAGs), which are popular as investment vehicles because they meet strict regulatory requirements for investors.

The ultimate aim is to raise €500 million for the vehicle, called MGPA Asien Spezialfonds. The fund itself is targeting Japan, Australia and Hong Kong as those markets offer low-risk real estate returns. The other established markets targeted are Singapore and Malaysia.