Debt investors are missing out on attractive risk-adjusted returns from senior and junior loans backed by commercial real estate in France, Italy and Spain, which are sometimes near double what is available in the crowded UK and German markets.
Europe’s real estate finance market is transforming itself. Insurers, debt funds and other non-bank lenders are jostling to occupy space vacated by banks. To date, however, the vast bulk of this new capital is focused on the more sophisticated UK and German markets, where competition is squeezing margins. Meanwhile, the rest of continental Europe offers much better value, particularly in Paris, Europe’s largest concentrated commercial real estate market.
For good quality, non-prime commercial properties in France, senior loans with a circa 65 percent LTV can achieve a 250-500 bps margin. For Italy and Spain, the margins are even wider. This compares with a 175-300 bps margin for an equivalent loan in the UK and 150-250 bps in Germany. Lenders obtain even wider margins if they are willing to finance transitional assets, or take renovation and letting risk. For mezzanine or subordinated loans, the difference in margin between the UK and Germany with the other European markets can range from 8-10 percent to 12-17 percent, illustrating a very interesting spot on a risk adjusted returns basis.
The reluctance of international debt investors to lend in continental Europe’s real estate markets stems from perceptions that these are unsophisticated jurisdictions, dominated by domestic or ‘pfandbrief’ lenders and unfriendly to creditors. While true to a degree, these issues can be addressed.
A sophisticated specialist local partner with Anglo Saxon market practices, discipline, and institutional training can mitigate the insider nature of these markets and enable international debt investors to identify attractive opportunities and avoid the bear traps. Pfandbrief lenders focus on more prime or well let properties with institutional sponsors. Local lenders focus on similar criteria and specific loan quantums.
How creditor rights are protected is the most challenging issue. The most notorious example is the case of Coeur Défense in Paris. In 2008, the SPV borrower owned by Lehman Brothers successfully petitioned the French courts for creditor protection on €1.6 billion of loans under Chapter 11-type rules. This precedent triggered copycat proceedings by over-leveraged sponsors seeking to freeze liabilities for up to 10 years in the hope that their equity would recover. International debt investors took fright at how it jeopardized creditors’ rights.
Italy and Spain’s length of enforcement appears easier to underwrite, since the locality of the court sets a clearer pattern on the time needed for legal proceedings, whereas in France, the duration of the creditor protection is the key uncertainty.
To mitigate this risk, structuring appropriate security packages is essential for any new financing or restructuring. This comes back to working with specialist local partners and law firms with restructuring and structuring experience.
There are now encouraging signs the lending markets are moving in the right direction. Two years ago, at the peak of the Eurozone crisis, Italy was so out of favour that no conventional market participants would underwrite loans and the few that occurred were funded by hedge funds or private family offices. A loan secured against a prime retail building with a 60 percent LTV and priced at a 9 percent coupon would fail to attract capital. Fast forward to December 2013, when Goldman Sachs securitized €363 million of loans secured against mainly secondary retail assets, and the financing was priced around 525 bps for an equivalent LTV.
There are phenomenal opportunities in continental Europe outside Germany. International debt investors can tackle these with the support of the right partner to generate attractive risk-adjusted returns.
First Growth has successfully sourced, structured and arranged over €350 million of debt capital for investors since mid 2010. In addition, First Growth restructures loans for both sponsors (€850 million to date) and provides special servicing to lenders (with recurring mandates of €1 billion).