Availability of finance in Europe is markedly two-speed and can be split clearly along the lines of jurisdiction and asset quality, writes Colin Throssell
For vanilla, prime assets in the UK, Germany and a handful of other Northern European countries, debt is available for quality borrowers. In fact, the draw of such assets is such that, between them, wholesale and retail bonds, traditional bank lenders, insurers, debt funds and even CMBS exits are reducing margins to levels not seen for some time – let’s call these assets ‘super-core’.
The story is markedly different for those assets that fall outside these criteria; assets which are considered secondary or that have a ‘story’ (such as developments), assets outside the main cities and, in particular, assets located in Southern Europe remain either debt starved or punitively priced.
This is mirrored by the investment markets. There has been a feeding frenzy for super-core investment property, while secondary property remains largely neglected. The UK is an example, where a wall of overseas money, looking for a safe bet, is driving down yields on trophy assets in Central London close to record lows, while the popularity and yields on secondary or regional assets continues to drift.
But for two reasons this will have to change.
First there is the risk that current lender and investor behaviour is creating a ‘mini bubble’, and those currently purchasing or lending on what they consider to be super-core assets are further up the risk curve than they think. Investors and lenders are beginning to wake up to the fact there are probably better risk-adjusted returns available, away from the herd, in those areas currently considered non-core.
Second if all available cash targeted at property via investors and lenders is to make its way into the sector, then those asset types the market is willing to consider investing in and lending on needs to expand; the investment capital that meets the currently narrow definition of super-core is simply insufficient to absorb this cash.
Perhaps it can be put more succinctly. Relative risk: returns, opportunity and competition will require lenders and investors to look more broadly than they are.
The cautious optimism on display by the various lenders we met at the international real estate convention MIPIM reflects this; lenders have balance sheet to lend but are competing hard (and rather too hard) only if a transaction is within their sweet-spot (by reference to location/jurisdiction, asset class and borrower quality, etc.) while many are quick to change tack (and emphasise the advantages of a quick no) when a transaction is outside this space.
It appeared to be increasingly acknowledged, however, that the lenders’ ability to successfully adopt such a narrow focus cannot last forever. A growing number are, to some degree or another, beginning to discuss the potential for ‘stretching’ their lending criteria in order to find and fund ventures where there are greater opportunities for pricing and relationship gains (assuming the two can co-exist).
What is interesting is the apparent disconnection between where the lenders and investors currently see these opportunities opening up.
For those investors at MIPIM, it was clear that Spain and Ireland were the hottest opportunistic European destinations.
It would appear that the willingness to face up and take the pain in both these jurisdictions (in large part via the creation of bad banks – NAMA in Ireland and more recently SAREB in Spain) has created a platform for realistic negotiations and pricing for investors – what has been referred to as ‘transparent professionalism’.
For lenders, however, it would seem that the very same process has crystallised losses, and that the wounds remain too fresh – and in many cases too large – to be tempted back into these markets at this stage.
Instead, lenders tend to be placing those jurisdictions where they have been able to extend and pretend (such as Italy), rather than facing up to sharp correction (such as Spain), further up their opportunity agenda. Here, corporate memory is not so burdened by actual losses, irrespective of future risks, when it comes to decisions on where lending and capital ought to be allocated.
One would not expect the disconnection to last for long: the relationship between property market performance and available finance is symbiotic; a thriving debt market is necessary to attract a wide pool of investors, and a steady investment stream is necessary to establish or stabilise market norms against which robust debt underwriting can be based.
As such, it will be interesting to see who admits to being wrong first in terms of identifying the right opportunities.
On the face of it, you would have to say that at least the investors’ strategy is founded on the correct principles – in other words, only in those markets where a ‘true bottom’ and level playing field have been transparently established can one make well-judged risk assessments. The banks would do well to note this for their approach, that past pain is somehow a strong indicator of a repeat dose, seems poorly judged. Given the cyclical nature of property market performance, it seems intuitively right that what has gone down ought to come back up (the investor strategy), and that something that barely appears to move despite all evidence to the contrary is probably performing an optical illusion that cannot be maintained forever (which lenders are choosing to ignore).
On this basis, one would expect lenders to ultimately follow their borrowers into the likes of Spain and Ireland, as and when time and tide has separated them from the raw pain of recent traumas. This seems more likely that borrowers feeling forced to seek opportunities in areas that get around the lenders current aversions.
The process is likely to be slow; the green shoots of spring are beginning to show in investor intentions (though not necessarily actions just yet) and we will need lenders to help tend these carefully by aligning their strategy with investors as soon as possible.
Certainly, one ought not to expect a deluge of transactions in 2013 in non-core markets, even if borrowers and lenders can align themselves in their decision over which is the right pick. Things ought to improve compared with last year’s slim pickings (not a single shopping centre transacted in Spain in 2012), but all parties are rightfully being careful when considering more complex opportunities.
Colin Throssell is head of property treasury at Henderson Global Investors