ROUNDTABLE | GERMANY: Dressed for distress

There is hidden distress in the German real estate market, and private equity real estate firms are gearing up in creative ways in their quest to uncover it. PERE magazine October 2011 issue.


Four real estate professionals dissect the investment opportunities in Germany, particularly the distress hidden among the nation’s banks

Tishman Speyer 
Peakside Capital
Corestate Capital

Germany is exhibiting a well-known syndrome: banks that cannot take large 'haircuts', crouched economic growth and politicians facing very large problems, particularly in the shape of Greece.

It was against that triumvirate that four real estate professionals took part in PERE’s annual roundtable focused on Germany.  

Hosted at Tishman Speyer’s MesseTurm high-rise office in Frankfurt, Phillip Burns, chief executive officer at Corestate Capital, Ruprecht Hellauer of Albulus Advisors Germany, Matthias Hünlein, managing director of equity capital markets at Tishman Speyer, and Boris Schran, partner at Peakside Capital, met to dissect the market. 

The backdrop was Frankfurt’s skyline, peppered by impressive-looking skyscrapers that stick up like needles. Such grand offices, though, mask the fact that many of the institutions – German banks among them – have suffered greatly in the downturn. This is bit of a metaphor perhaps for the way some of the roundtable participants view Germany as a ‘hidden distress’ market. 

Behind all that shiny glass, there are banks that simply are not lending to real estate anymore and have huge amounts of real estate debt that they will need to deal with eventually. For example, take WestLB through its real estate lending subsidiary WestImmo, which Hellauer says loaned just €57 million to new deals in the first six months. Meanwhile, WestImmo itself is up for sale and is being pursued by private equity firms.

“I think there is still a lot of hidden distress in the German real estate market, particularly in the banking sector,” says Peakside’s Schran. “There are a lot of situations that have not yet surfaced and are maturing slowly. This presents one of the opportunities that can help deliver the kind of returns we are looking for.”

The banks seem to hold the key – and in some cases, they stand between these real estate professionals and the type of deals they are trying to achieve. Still, some deals are moving.

In September, for example, a package of nonperforming loans with a face value of €370 million was sold by four German banks – Eurohypo, Landesbank Hessen-Thüringen, Berlin Hyp and Archon Capital Bank. Those loans were made to one single borrower to develop properties, primarily in Berlin and Frankfurt, in the mid- to late 1990s.

Fading growth

Before they went any further, however, the four participants felt the need to address a sweeping economic force at play in Germany today: economic growth appears to have dissipated. Figures out over the summer suggested that the German economic growth ‘miracle’ is fading. Gross domestic product shrunk in the second quarter to just 0.1 percent after registering 1.3 percent in the first quarter. 

The German slowdown was blamed on a number of factors, such as weaker domestic consumption, construction and energy production. It is a stark contrast to this time last year, when those involved in the real estate market in Germany were joyous that gross domestic product was roaring ahead.

For all the negative headlines about Germany stalling, it didn’t seem to matter too much to the roundtable participants. Corestate’s Burns says one might need to assume growth if one were investing in emerging markets. Or, if one were investing in the US, the investment thesis might be more about betting on the flexibility and dynamic nature of the economy. 

“Nobody should be coming to Europe for a high-growth strategy, whether it is at the core or opportunistic end of return expectations,” Burns says. “In particular, you are coming to Germany because you like the stability, you like the strength and the diversification. Growth is potentially icing on the cake. If you are doing what Corestate is doing, you do not need high growth. You need to be able to source interesting opportunities where you can buy well. Equally important, you need to be able to increase value on the operational and repositioning side. People who are worried that German growth might be slowing are missing the point of what we are doing.”

Hellauer, whose new firm Albulus is tapping the newly emerging opportunities in the German nonperforming loan sector, notes that Germany had never been a tremendous growth story. “There is relative stability and, when going into the distressed arena, you get a discount to the collateral value by buying the loan and secure assets below replacement cost,” he argues. “Therefore, you do not need the market growth to help you out. You have to resolve the loan, collect recourse obligations and increase the asset value to the point where you make your return.” 

Size of the opportunity 

So, how much distress truly is to be found in the German real estate market? One measure would be based upon the German banks and their real estate debt exposure.  

Trepp, a company that provides commercial mortgage and mortgage-backed securities information, produced a detailed report on 17 August, crunching the numbers of some 90 European banks following the stress tests they were obliged to perform by the European Union. Predictably, the study found UK and German banks had the greatest exposure to commercial real estate at €317 billion and €255 billion, respectively. (Italy, Spain and Sweden ranked a distant third, fourth and fifth.) 

Experts estimate there is approximately €300 billion in the entire German banking system, counting commercial real estate loans from domestic and non-domestic banks both inside and outside the stress test.

According to Trepp, €17.3 billion in loans at the German banks that were stress-tested had defaulted. That is the second highest amount anywhere in Europe, equating to a default proportion of 9.6 percent. Although not the highest rate in Europe, it still is significant. The question, though, becomes whether many banks will sell any of that at a discount.

Figures relating to the volume of opportunistic direct real estate deals in Germany seem to back up a view that not that much has been resolved, at least for now. International property services firm Jones Lang LaSalle published 2011 half-year data suggesting €20 billion in property deals occurred in Germany, which is just a third of the volume realized during the peak a few years ago. Core deals, especially for retail property, shot up and accounted for more than 60 percent of those deals transpiring in the first half. Core-plus and value-added deals similarly rose as a proportion, estimated at around 30 percent. However, opportunistic deals have fallen to just two percent, meaning that segment of the market has frozen up and neither banks nor developers have been able to work through it.

Tishman Speyer’s Hünlein, whose job is to raise capital in German-speaking markets and the Nordics for all of the firm’s funds, links that cliff-like drop in opportunistic deals to the unavailability of bank debt. “The point is that there is capital for opportunistic-type deals, but what you are missing is credit,” he says. “If you are trying to generate 15 percent-plus returns and you have to put in 30, 40 or 50 percent in equity, you are not going to get there.”

From his point of view, Schran reckons that sellers´ price expectations generally were not reduced sufficiently enough to allow large foreign funds to generate their returns, which is why a lot of things are “not yet moving. On the other hand, you see a lot of movement on the small investor end – the private guys, the local developers and the smaller family-type of investors. There you have seen fairly healthy momentum and deal flow recently. Some of the banks cannot afford to take big hits, but they might be able to afford them on the mid-sized deals. Here, the competition is not as great.”

Indeed, the market is almost bifurcating. “Large funds don’t care for mid-size tickets, and private or local investors do have not sufficient capital,” Schran says. “This is where you could find individual nonperforming loan-type situations with a need for capital and the opportunity to add value by improving the operational side. In this niche, there is still little moving, but I am confident that this will change.”

A holistic approach 

There was general agreement around the table that delivering opportunistic returns just from the entry price was extremely hard, which necessitated a different approach than simply beating the banks. “We are trying to get 1.5x or 2x return on capital,” Burns says. “We would need to buy at a 50 percent discount to the collateral value in order to achieve that on the price alone. You are just not going to get that today. You didn’t get it yesterday, and you are not going to get it tomorrow. It means you have to do deals that deliver value other than simply at the bank’s expense.”

In the past year, several of Corestate’s deals have involved restructuring debt. One was with a German bank, while another involved an existing securitisation. Corestate did not require a bank or a bondholder ‘haircut’ in either case. “Those deals happened because we provided a holistic solution to the banks and bondholders,” Burns says. “Going forward, I do not believe the banks will accept significant write-offs simply because they cannot afford it. There is nothing I see in the next period of time that is going to fundamentally change that.” 

In a slight contrast, Hellauer says: “The banks we are talking to have built certain reserves if a loan is nonperforming. One bank we are talking to has had a loan for years, the asset is not performing, there are horrible asset management issues and they don’t want to meet capital expenditure requirements or make tough decisions. That’s the stuff we have been buying.” 

Another of the points agreed upon involved the need to produce core product to sell to the market. That is, in essence, what Corestate and Peakside are doing with their assets, dragging up their quality. It certainly is the game plan of Tishman Speyer, the New York-based doyen of large-scale Grade A offices. 

Tishman proved its forte last year, when it sold the huge OpernTurm skyscraper in Frankfurt that it developed with partner UBS to a joint venture between a core fund managed by JP Morgan Asset Management and the Government of Singapore Investment Corporation for between €500 million and €600 million. 

Besides investing in projects directly, Tishman Speyer also has been buying into the financing structure of a deal, with the ultimate goal of controlling the asset. “We did a deal like that in Chicago not too long ago, when we bought a certain mezzanine tranche and received pre-agreement with bondholders that we eventually would take over the building,” Hünlein says. “We see opportunity in looking for complex situations where you need to have the full spectrum of tools, such as bringing in partners and dealing with the financial as well as the asset side.”

In the US, the trigger for transactions has worked much better than in Europe, Hünlein notes. The situation in the US is simplified in that values have recovered to a point where banks are close to getting to a break-even point on their loans, resulting in a number of transactions as they “pull the trigger” on the equity holder, he explains. “We haven’t seen that yet in Europe,” he adds. “Many of the assets are parked in ‘bad banks’.”  

Tishman Speyer, however, has capital for both core and value-added transactions that it is putting to work. It recently bought an asset in Paris for a value-added fund when the office had a vacancy rate running at 20 to 30 percent. “This is the kind of deal the firm believes might be available in Germany,” Hünlein adds.

Core exits 

Proving how much equity there is for core assets, Tishman Speyer didn’t need to go to Asia to find a buyer for the Opern-Turm, as Asian buyers already were in Europe looking to diversify their holdings and currency. And more large deals are pending in Frankfurt and Berlin, for which there is a lot of capital, Hünlein notes. 

One recent example of fresh capital is Deutsche Bank, which raised money from retail investors through its mutual funds business, DWS. The closed-end fund bought Deutsche Bank’s headquarters in Frankfurt for a reputed €600 million.

Corestate’s Burns agrees that it is a sellers’ market. “I believe it is about having core or core-plus product to sell,” he says. “The things that we have bought in the last 18 months are being repositioned.” 

Summarising the firm’s overall strategy, Burns expects to continue executing deals similar to the ones done of late. “It probably will be a mix of residential and commercial,” he says. On the residential side, it will be working with lenders, special servicers and insolvency agents to find a holistic solution that will be less driven by write-offs and more by creativity and operational capabilities. In commercial property, it will be repositioning offices and taking a risk with short leases, and there will be some retail as well.” 

For its part, Peakside will continue to review strategies such as Berlin residential property and selective office conversions. While “buying right” remains its key investment condition, one of the main themes remains converting broken assets or situations to core product through market and product expertise. Lastly, it believes it can involve itself in certain restructuring situations, where it can introduce operational expertise by exploiting its experience and broad partner network.

Strategic advantage

At the beginning of the discussion, Hünlein had made some introductory remarks, relaying feedback from equity sources that suggested how fund sponsors with broader strategies had performed better than specialist funds. “It is interesting to see investor appetite or approach move over time,” he says. “I have been speaking with a number of investors that have performed an analysis on their existing portfolios and are trying to figure out the most successful strategies. Some of the findings were rather unexpected.” 

Whether a generalist or a specialised fund strategy is better cannot be known for sure. However, the common feeling among the roundtable participants was that, if they can just bring their unique knowledge to bear, they ultimately will satisfy their investors. 

Germany has never been a growth story, but the market’s hidden distress should lead somewhere. Ultimately, it is going to come down to the skill and courage of those that operate in the market. 

Boris Schran
Co-founding partner
Peakside Capital 
Schran is a founding partner of Peakside Capital, which was created through a management-led buyout of Bank of America Merrill Lynch’s private equity real estate business in Europe. Prior to the buyout, he was a director responsible for origination and execution of transactions in Europe. 
Peakside works on three different pools of capital: one being the management of existing assets for Bank of America Merrill Lynch, another being capital for a Turkey-focused fund and the main one is a fund with a pan-European opportunistic strategy. The firm is focused on complex situations where it can add value through structuring expertise and subsequently apply its hands-on asset management approach. 
Peakside recently made a fresh investment in the Berlin residential development market. Schran says the firm saw an opportunity in German commercial property conversions into residential and office space. Peakside manages just north of €2 billion in gross assets in a broad range of investments, from NPLs to office and residential properties.

Matthias Hünlein
Managing director, equity capital markets 
Tishman Speyer
Hünlein is Tishman Speyer’s pointperson for clients in the German-speaking countries and the Nordics across all of the firm’s products. Prior to joining Tishman, he worked at DB Real Estate, an investment subsidiary of Deutsche Bank, for 11 years, where he was responsible for product development and relationship management.
The New York-based development and investment management firm clearly has returned to transaction mode, completing several deals in the past six months in the US and Europe in the core and value-added space. Hünlein notes that the capital raised for past strategies has been invested for the most part, meaning the firm is once again on the fundraising trail. 

Phillip Burns
Chief executive officer 
Corestate Capital
Burns is chief executive officer of Corestate Capital, a value-added and opportunistic private equity real estate firm with offices in London, Frankfurt, Luxembourg and Zug, Switzerland. He formerly worked at Terra Firma Capital, where he served as financial managing director and managed the firm’s German office, including its large investments in German residential property.
Corestate, which historically has focused on Germany, specialises in adding value to investments by improving operational aspects through its asset management capabilities.  “The cleaner an asset is, the less likely we would be interested in it,” Burns says. “In order to drive the kind of returns we are looking for, investments usually need a lot of work to be done.” Corestate has a 20-strong asset management team in Frankfurt and around €1.5 billion in investments.

Ruprecht Hellauer
Albulus Advisors Germany
Hellauer is the founder and former managing partner of Lohnbach Investment Partners, which specialised in acquiring nonperforming loans in Germany. The Frankfurt-based company tried to “stay below the radar screen of the investment banks” by concentrating on smaller portfolio transactions, with each of the loans typically around €10 million. After seven years and more than €1 billion in loan investments, he left to establish a new venture, Albulus Advisors Germany, to concentrate on the same area. 
At Albulus, Hellauer is arranging investments in nonperforming real estate loans backed by commercial real estate and multifamily assets. “When you buy a nonperforming loan, you normally pay 75 percent to 80 percent of the collateral value as the purchase price,” he says. “This is a deep value investment, as you do not need market growth to achieve your return target. And even if the market works against you, you might be working for free, but at least you are not losing equity.” 

German distress by the numbers 

€255 billion: 
total global commercial real estate 
exposure of German banks

€117 billion: 
total domestic commercial real estate exposure

€17.3 billion: 
defaulted commercial real estate loans on 
the balance sheets of stress-tested banks

11 percent: 
loan-to-value covenant breach of CMBS 
backed by German real estate

€7.5 billion: 
upcoming maturities of CMBS loans 
backed by German real estate 

30 percent: 
proportion of commercial real estate loans extended

number of CMBS loans reaching 
final maturity in July 2013

number of German CMBS loans that 
had realised a loss as of Q1 2011

50 percent: 
maturing loans that are not expected 
to achieve an orderly repayment

Sources: Trepp, Jones Lang LaSalle and Fitch Ratings


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