Survey shows earlier expectations of a ‘wave of distress’ may have been overstated, writes Sebastian Krautz

It is hard not to notice that the expected wave of transactions of distressed real estate loans has not taken place – at least for now. Several research studies in 2012 each predicted such a wave for 2013 and the following years, but it failed to materialise. The expectations of industry professionals have changed greatly since last year.

The number of non-performing real estate loans that will come to the market in the future is expected to be substantially lower than was anticipated, according to ‘Survey on the State of Real Estate Financing and on the Distressed Real Estate Debt Situation in Germany’. The study was conducted by the research unit Distressed Real Estate Debt, jointly operated by Corestate Capital and the Real Estate Management Institute of the EBS Universität für Wirtschaft und Recht. Trends among determining factors such as gearing ratios, maturities, and financing volumes suggest that banks have become more assertive and are extending their loans. At the same time, fewer banks are increasing new business in the German market.

The present opportune interest rate is certainly one reason for the low number of distressed real estate portfolios on the market. Banks are provided with an abundance of capital since the European Central Bank announced its bond-buying programme.
Therefore, the pressure on banks to sell their distressed real estate loans has decreased.

The ECB’s programme, paired with the historically low interest-rate environment and rising real estate prices, removes the pressure from banks. The ‘extend and pretend’ approach does not work anymore, since distressed loans moved so much into the centre of interest and became increasingly difficult for market players to hide the conditions of their loans. However, only an ‘extend’ approach is the way to go at the moment. The prolongation, even with breached covenants, gives time to the debtors for another chance to straighten things up, rather than dispose of those loans at a high discount.

The survey shows that the financing landscape is still undergoing structural change.
Banks continue to implement regulatory measures and impose higher capital requirements or scale back their activities completely. With respect to gearing ratios, banks are getting more confident again. In 2012, the loan-to-value (LTV) ratio of office and logistics financing ranged mainly from 50% to 60%; this year LTVs increased to levels above 60%, which is the new standard. Compared with 56% in last year’s survey, now 72% of the participating banks most commonly grant loans with LTVs greater than 60%. This accounts for all usage types, including project developments. It is expected that LTVs will remain at current levels during the next two years. Only those for office, retail and project development are likely to rise, according to some participants.

Contrary to last year’s expectations of shortening financing maturities, the life span of newly granted loans actually lengthened. Now, standard loans vary between five and seven years, compared with three to five years in last year’s poll. Residential real estate loans have a substantially longer life span: over 65% of the loans handed out in 2013 have a maturity of more than seven years (about 40% in 2012). The participants’ expectations for 2014 and 2015 suggest that maturities for most sectors will remain stable or, in the case of office and shopping centres, financing may rise slightly.

According to the opinion of the polled executives, the anticipated discounts on distressed real estate debt will increase within the next two years, but this will take place at a lower level than forecast in 2012. Similarly to last year, 26% of the respondents consider selling distressed real estate assets in the next two years.

This year’s survey shows how significantly the sentiment in the market can change within one year. The outcome of the 2012 survey was clear: distressed real estate loans in Germany will increase in both number and transaction volume over the next two years.
Moreover, a higher willingness to dispose of distressed loans in 2013 and 2014 was expected. It was also predicted that German banks would exercise more caution in their future lending, and raise debt-servicing obligations slightly for debtors.

Surprisingly, the expectations of the same group of people changed considerably compared with the answers given 12 months before.

Even though the survey participants still expected to see a greater willingness to dispose of distressed real estate debt in 2014 and 2015, the transaction volume is lower compared with last year’s forecast. Also, the expectations about necessary discounts have decreased.

This poll was conducted between May and July 2013. A standardised questionnaire with 13 questions was sent to 57 industry professionals, including CEOs, CFOs and managing directors, from 32 commercial real estate financing institutions.

Sebastian Krautz is director of the Corestate Research Unit for Distressed
Real Estate Debt,Real Estate Management Institute, EBS Universität für Wirtschaft und Recht