Built to last
Lenders and investors are backing the future health of real estate finance, according to a new report, writes Claire Watson
Over the past five years, the real estate sector has faced a series of potentially devastating blows: the sub-prime crisis was quickly followed by the European and US credit crunch, the collapse of Lehman Brothers, the part-nationalisation of various European banks and the continuing struggle to get Western economies growing again.
For months after Lehman’s demise, the European real estate debt market was gridlocked. Leverage fell, margins increased and assets and sponsors were under intense scrutiny. For many observers, this was to be the basis for the future of real estate finance.
And yet despite all this, real estate has managed to prove its naysayers wrong. It remains an attractive and fundamental asset class for investors in the key cities of Europe, the US and Asia and, despite current challenges, there is still finance available for quality assets in key locations.
Given this optimism, we decided to ask leading banks (including the clearing banks) and a range of investors what they felt the future of the market held. The results, recently published in our ‘Real Estate Finance: Financing the Future’ report, are encouraging: lenders and borrowers alike confirmed the resilience of the sector. As Brendan Jarvis, head of real estate at Barclays Capital, told us: “Real estate is a resilient asset class over a period of time and almost everyone would agree that it is a cyclical business. And, of course, the best time to lend in property is when liquidity is poor and value low.”
Although many of our respondents felt that overall lending would remain flat or show only moderate growth, we are seeing an increase in the scale of repayments – for the first time in a long time many banks are re-investing these repayments in real estate lending rather than using the money to shore up their capital base or diverting the money to other asset classes. Financial institutions increasingly see real estate as fundamental to a balanced lending book, particularly where, as one respondent put it, “real estate is a fundamental part of the economy”.
Perhaps unsurprisingly, our respondents confirmed the prevailing market view that lending from non-bank financial institutions, such as insurers, pension funds and private equity houses, will increase. Certainly, the rise of ‘new entrants’ in the real estate lending market has attracted more attention over the past few years.
The common view was that these institutions would play an important role in broadening both the asset classes and the investor base, and therefore put increasing pressure on banks to diversify their portfolios to generate returns. We have already started to see that happen, and the way this takes shape will dominate the agenda over the next five years as financial institutions look to increase their returns while managing their exposure to risk.
Arguably, this wave of newcomers could also include banks new to lending in specific geographies or sectors. Without any pre-credit-crunch baggage, these organisations are in the fortunate position of being able to consider all opportunities in the market. The challenge for the markets, though, is to find ways of funding those assets that are no longer considered ‘prime’. Perhaps some of the new entrants, such as senior debt funds, allied with investors who understand the assets, might help to bring some much-needed liquidity to these assets.
Away from lending, an intriguing development from an investor’s perspective is an emerging back-to-basics approach to real estate investment structures.
Interviewees, however, stressed to us that it would not be right to view this as a simplification of real estate finance; it is more a case of understanding that, first and foremost, the centre of any property transaction, whether investment or lending, should be the property itself. This was neatly summarised by Andrew Appleyard, head of specialist real estate funds at Aviva Investors, who said: “Simple loan structures are best and this works for people who are risk-averse. The ability to understand what you have actually done in a financing is going to be paramount.”
Real estate activity in the UK over the past few years illustrates investors’ continuing faith in the sector. The total deal value of transactions in UK real estate in 2008-09 hit a low point of £19.5bn (€23.4bn). Received wisdom at the time predicted that the market would remain depressed for years, but the value of transactions in the market actually rose by almost £10bn in each of the following two years. While this growth was not necessarily mirrored by increases in new originations, there certainly has been a steady increase in the amount of new money injected into the certain sectors of the market.
This view is backed up by Tom Walsh of Rockspring Property Investment Managers: “The UK is attractive for a number of reasons: transparency, liquidity, truly global market, volatility, strong rental growth prospects and the obsolescence of existing stock.”
We all know how tough the market has been, but we have clear evidence that lenders and borrowers remain fully committed to real estate. Recent months have shown us that there are very good returns for investors and lenders who are prepared to take a flexible approach to gaining value from real estate.
New conditions have led to a focus on simpler financing, while new players have joined traditional lenders in the bidding wars. While there are no signs of any return to the old culture of financing, what is clear is that property remains a formidable and fundamental asset class.
Claire Watson is a real estate finance partner at Berwin Leighton Paisner