Traditionally, there has been a common belief that in any real estate market recovery, distress funds are the first to arrive and, once these start packing, core funds follow.
In Spain right now, the core funds are currently quite active, with transactions completed at sub-3 percent cap rates – record lows for the country.
Are the distress funds leaving the country, then? Definitely not. If anything, they are accelerating their activity. There are at least two ‘gorilla transactions’ that have raised much interest of late: the sales at Banco Popular and BBVA, both of which include a servicer and a substantial real estate exposure.
If these transactions finally close, they would have a significant impact on the Spanish non-performing loan market, as they represent two of the last remaining large-scale exposures to be transferred to private real estate investors and which will cease to be NPLs, becoming simply assets.
Why has moving on taken so long? Firstly, Spain’s distress is today mainly concentrated in the residential sector, or are collateral properties in non-prime locations. Also, most of the largest NPL portfolios that have sold had different residential exposure throughout Spain, including things like land, half-finished developments and development loans.
Therefore, servicing capacity was a must. A substantial part of that exposure was in areas of Spain that lagged the country’s broader economic recovery. Much of the pricing in these parts is still very low in absolute values given the uneven recovery throughout the territory.
Arguably most importantly, the strategies of the global private equity funds that tend to buy NPLs have to firmly believe in a strong and sustainable macro recovery in Spain as their investments are rooted on such calls. None would be active if they saw little clarity for several years.
What is the general state of the NPL market in Spain? Before these two mega-transactions, altogether the financial institutions and the national bad bank Sareb were considered to be about halfway through their clean-ups having reduced gross exposure from €300 billion at its peak to between €140 billion to €160 billion today.
The strongest are more advanced with the reduction of their NPLs than the weaker, as with Banco Popular. My old employer, Sareb, has no capacity to use ongoing banking business to further increase provisions. Given its initial equity and P&L, it will be the slowest banking organisation to finalize its NPL reduction. So far, its initial balance sheet has decreased by approximately 20 percent, from €50 billion to €40 billion.
The Banco Popular and BBVA transactions represent a substantial share of the country’s remaining exposure.
Nevertheless, I would estimate there are still two to four years remaining for a final material clean-up, given the annual pace of divestment that these institutions have managed through portfolio sales or using their retail channel through their servicers.
What does all this mean for the Spanish real estate market? An obvious impact would be that financial institutions grow stronger balance sheets. Consequently, they would probably be more open to finance, which could likely trigger an increase in LTVs. That would have an immediate effect on the weighted average cost of capital and therefore on the pricing of the assets.
Also, there would be more equity and more liquidity in the system, which would irrigate the economy with further increases in consumer expenditure and employment. This would probably translate into the strengthening of real estate fundamentals leading to a potential increase in both rents and leased space.
Finally, a third consequence – and one intrinsic to these portfolio sales – is the amount of additional investment carried out by these opportunity funds that would happen to improve the assets before they are sold. This would activate areas of the economy still lagging Spain’s broader recovery.
That is something practitioners in the market like myself can look forward to.
Juan Barba is a managing director at Meridia Capital, a Barcelona-based fund manager.