The deleveraging of banks has created an attractive opportunity in the commercial real estate debt space, argues investment consultancy Redington. As a result of the ‘significant improvement’ in the risk-adjusted returns on offer, the advisor is urging pension funds to build exposure to the asset class.
Outstanding European debt secured against commercial property and due to mature in the following ten years amounts to €960 billion, according to Redington. Approximately 75 percent of this is held on banks’ balance sheets, and just over 40 percent is due to mature in the three year period between 2013 and 2015.
“We find senior secured lending opportunities where banks have been forced out of the market due to increased capital requirements (Basel III) and balance sheet costs,” said David Bennett, managing director at Redington Investment Consulting. “Specifically, commercial real estate lending and SME lending can conservatively match the 3 percent to 5 percent equity risk premium.”
Kate Mijakowska, a senior research analyst at Redington, explained that as a result of this gap, there would be two detrimental positive shifts in the CRE lending market.
Firstly, the typical loan-to-value levels of the senior debt portion have fallen dramatically, from 75 to 80 percent all the way down to 50 percent to 60 percent. Secondly, at the same time, the lending spread being charged on this senior debt has widened from approximately LIBOR + 50-80 bps to a range of 300-450 bps over LIBOR.
“Lending covenants have been strengthened significantly, and additional equity contributions from real estate owners have increased,” added Mijakowska.
About half of the outstanding European commercial real estate debt is secured against real estate in core countries such as UK and Germany, she added.
Significant falls in real estate capital values have already occurred over the past few years, according to the firm’s March report. “Lending covenants have been strengthened significantly, and additional equity contributions from real estate owners have increased.”
The response from pension schemes and insurers has been described as encouraging, but Mijakowska warned the recommendation is only directed at investors with sizeable portfolios. “Due to the illiquidity of the assets, the budget needs to be large enough to accommodate investments,” explained Mijakowska.
In addition, Redington argues the market will soon have a sufficient number of asset managers to allow pension schemes to gain direct exposure to commercial real estate debt.