Spain Will the new ‘bad bank’ and a revamped REIT regime encourage investors back to the Spanish property market? Shayla Walmsley reports

 

Spanish legislators should beware acronyms, says José Luis Suárez, a professor at the University of Navarra. First there was the SOCIMI, Spain’s REIT structure – “a mistake” in its original 2009 incarnation, though recently improved. Now there is SAREB, the “bad bank” set up to absorb non-performing loans from domestic banks’ balance sheets.

It is too early yet to gauge the likely impact of either. SAREB will need to operate effectively in a macro-financial context of private-sector deleveraging, tight credit, falling house prices, fiscal consolidation and weak confidence. In the IMF’s first progress report on Spain’s financial services sector reform, published in November, it anticipated a further contraction in 2013 and thereafter a slow recovery.

The residential market, especially, is unlikely to improve anytime soon. House prices, down 30% from their peak, are still falling, with weak demand and a serious overhang likely to prolong the correction. The pace at which SAREB disposes of residential assets worth €35bn could have implications for Spanish house prices by creating reference prices for the market.

Within limits, that is. Suárez, who also blogs on the Spanish property market, believes the bank’s activity will have at most a minor impact on house prices because the bulk of its residential assets are development projects. “SAREB will try to protect value but the final price will come, as it always has, from market forces,” he says.

Yet the potential for market distortion is one of the issues identified by Vincent O’Sullivan, an economist at the University of Limerick, who has analysed the distortion effects of bad banks, including Ireland’s NAMA. O’Sullivan believes the size of SAREB’s balance sheet and the concentration of its portfolio could similarly create distortions in the Spanish market. “The Irish banks were left to sort out the smaller loans. That’s why NAMA’s impact could be more pronounced,” he says.

In the meantime, potential buyers in the Spanish market – the few there are – have little idea of what will be for sale, and at what price.

Although the agency’s framework was already in place by mid-August, it wasn’t until December that it set up operations and, even then, it told investors very little about likely discounts. It matters because the assets comprise significant volumes of land and underdeveloped property. Investors might consider weaker markets if they see discounted pricing, “but it would have to be prices you couldn’t refuse”, says Peter Damesick, chairman of EMEA research at CBRE.

Simon Martin, a partner at Tristan Capital Partners, is one potential investor holding out until he sees the detail. “All we’re seeing is a transfer from the banks originating the loans into the bad bank. There is no evidence that the bad bank is selling them into the market,” he says. “To that extent, we only have an idea of the discount the bad bank is paying, not on what is on the books or the price at which it will try to sell them.”

Tristan is focusing its efforts on midmarket value-added transactions, rather than the large loan portfolios likely to be targeted by distress-seeking investors. “We want nice institutional assets, not big land portfolios,” says Martin. “Lot sizes will have to be attractive, and we’re after the asset, not the loan. We’re not averse to buying into a loan structure but the underlying real estate has to be top quality.”

The quality of the collateral is the principal problem for Spain’s real estate-related debt. International investors want income-producing assets; SAREB is offering residential developments.

The revamped REIT structure gives investors a domestic listed alternative to direct investment in SAREB assets. The fact that SOCIMIs will be underpinned by high-quality assets potentially makes them more attractive from investors’ point of view than the questionable portfolios SAREB will be offloading. By removing the tax penalty the original version had left in, the SOCIMI provides, says Suarez, an international-standard, potentially industry-reinvigorating investment route.

As Philip Charls, CEO of the European Public Real Estate Association (EPRA) points out, investors will only opt for REITs if they abide by the rules on transparency and proper regulation. But, just as importantly, they need to hold high-quality assets.

“The message is: don’t offload poor quality assets because it won’t work in listed real estate,” he says. “REITs will need to fulfil the requirements of quality assets, quality management, and an income play.”

Even the combination of NAMA-isation and REIT revamping is unlikely to have much impact before any economic recovery, which is not predicted to arise before 2014. Most investors are unwilling to commit capital in an uncertain Spanish real estate market, although this, of course, does create opportunities for those willing to be first movers, such as Orion Capital Managers, which in 2011 acquired 50% of Puerto Venecia shopping centre in Zaragoza for an undisclosed sum via a joint venture with British Land.

“When there are drastic measures, there are always opportunities,” says Orion managing director Aref Lahham. “The lack of liquidity in the market allows investors to get exposure to good assets at value pricing. Normally, you wouldn’t be able to get them at those prices but a liquid market allows us to go hunting.”

Lahham says it only makes sense for Orion to invest in a market on two conditions. The first is the expectation of a macro rebound: at some point – he reckons in five to seven years – the institutional investor money will come back in. The second is that the asset will be cash flow-producing in the meantime. “Once capital flows have left the country, it could be a long time before yields come back in,” he says. “You have to choose carefully for cash flow in the meantime, but with an asset that will perform when yields come back in.”

But Orion and other opportunistic managers are choosing carefully in a limited market characterised by mispricing. Lahham acknowledges assets are not easy to find. “It isn’t a firesale and that makes things difficult,” he says. “Every once in a while, if you look hard enough and work hard enough, you’ll find one. We’re looking for jewels – but it isn’t easy.”