The land of opportunity
Global distressed debt investors have turned their attention to Europe as banks deal with problematic property loans. Lynn Strongin Dodds reports
Ever since the onset of the financial crisis, distressed debt funds have been circling troubled real estate markets, waiting to pounce on opportunities. The US had been the most promising hunting ground, but attentions have moved to Europe as banks there finally begin to tackle problematic, non-performing assets.
The task is a daunting one. According to figures from Morgan Stanley, European financial institutions had an estimated €2.4trn of commercial real estate loans on their balance sheets as of November 2012 with sales from 2010 to 2012 amounting to just €93bn. The combination of economic stability, the European Central Bank’s new role as regional bank supervisor and the treatment of non-core real estate and real estate-related assets has served as a trigger to deleveraging.
In fact, as Laurent Luccioni, head of commercial real estate EMEA at PIMCO, points out, most of the top 50 banks in Europe have now established dedicated non-core divisions, with four of the top 20 institutions creating these in the past year. “The pace has accelerated in Europe this year but the picture is not uniform, with the UK, Ireland, Spain, Italy and Germany moving at different rates. However, a report from PwC shows that there has been an increase in the number and volume of transactions over the past two years. CRE loan transaction activity is expected to reach approximately €60bn in 2013, versus €46bn in 2012, and €36bn in 2011.”
Marcus Palmer, head of real estate debt at Hermes Real Estate Investment Management, says: “We have seen significant-sized fundraisings by the likes of Oaktree, Blackstone, Starwood and Lone Star, although acquisition activity has been largely stunted until this year. There continues to be increasing pressure on banks from regulation such as Basel III and slotting to unload real estate asset loan portfolios. Hardly a month has gone by since mid-2013 without a debt portfolio transaction being taken to market.”
Andrew Radkiewicz, co-head of Pramerica’s European business, echoes these sentiments. “There has been evidence at the end of 2013 of increased activity,” he says. “I think there are a number of factors contributing to this such as stronger macro real estate fundamentals and greater liquidity in non-prime markets. The banks are now more comfortable to sell but most of the portfolios coming to market are stressed and not distressed. The US was different in that their banks dealt with the problems much quicker because of the mark-to-market regulation.”
The funds that are being deployed are casting their nets wide and the sectors are multifarious, according to Chris Holmes, head of UK debt at Jones Lang Lasalle. “To buy at the widest discounts to par, the investors are happiest buying mixed sector assets across regions which for the previous lender would have been very disparate to manage. Secondary hotels through to shopping centres feature highly in these portfolios as well as unit shops. The jurisdictions that have featured highly in terms of volumes this year have been Ireland, the UK and, increasingly, Spain. Non-performing loan (NPL) sales are slow in countries such as Germany and Italy, although there are clearly impaired loan books here.”
UK-based Lloyds has been one of the most aggressive sellers as it tries to shake off the HBOS legacy and free itself from the 33% government holding. The most noteworthy deal has been the disposal of the so-called Project Thames, one of the bank’s largest portfolios of poorly performing loans to date. It is understood to be tied to 50 loans from 30 separate borrowers, secured against 180 properties in so-called secondary locations throughout the UK. The competition was fierce, with reports that at least three or four private equity groups were clamouring over the properties with Cerberus Capital Management emerging as the victor, paying £325m (€390m) for the prize at a 21% discount. Meanwhile, fellow private equity firm Apollo snapped up a portfolio of non-performing Irish retail mortgage loans dubbed Project Phoenix for £257m, which reflected a 57.8% discount.
Royal Bank of Scotland, on the other hand, has been moving at a leisurely pace. The 83% government-owned bank had focused on either selling assets on the continent – such as the disposal of a €1bn portfolio of commercial real estate in Germany last year – or on individual properties in the UK. However, the creation of an internal bad bank to house £40bn of its toxic assets, after a government review stopped short of recommending that the lender be broken up, led to the first sale of UK distressed properties. The 28 industrial distribution units dubbed Sapphire Project was sold for £63m to hedge fund group Varde Partners at the end of the year and more assets are to be placed on the block in 2014.
Private equity and hedge fund groups have also found Ireland a fertile ground for deals.
The tempo has accelerated in 2013, with Ireland being the first country to formally exit the bailout programme funded by the International Monetary Fund and the European Union.
The country’s bad bank, the National Asset Management Agency (NAMA), led the sale of its first big tranche of commercial property loans to a joint venture where it had a 20% slice, with the remaining 80% stake owned by Starwood Capital, Key Capital Real Estate and Catalyst Capital. The portfolio, which had a face value of €800m, was thought to have been sold for €200m. The aim is to sell off at least €1bn of properties and loans in 2014, if the economy continues its slow and steady climb.
This is in sharp contrast to three years ago when NAMA was launched. Not only were the loan losses higher than initially expected but the country’s commercial property prices had dropped by more than 60%. In addition, sales were delayed due to the sheer time it took to sift through the vast loan portfolios worth an estimated €32bn. “NAMA is under continued pressure to divest its loans and there has been a lot of general loan sale activity this year,” says Peter O’Brien, partner, banking and financial services group at leading Irish law firm Matheson. “US private equity firms have been active, but there is a lot of attention in general on Dublin because of the recovery in the commercial real estate market.”
Activity is also rising in Spain where the government recently created its own bad bank called Sareb. Nationalised banks such as Bankia, Banco de Valencia and Caixacatalunya have already transferred the bulk of their bad property holdings and loans worth some €50.5bn. Around seven portfolios have already been put out to tender, including stakes in tourist resorts and a shopping centre, homes and syndicated loans to property developers. However, the buyers are not alternative funds but financial institutions such as Deutsche Bank, which recently bought two portfolios of loans worth a total of €323m.
“As we predict a slow recovery in the Spanish market, it would be a good time to unlock the NPLs there, and Sareb is moving forward with a strong sales programme in 2014,” says Holmes. “Again, the sector types are multiple here, with residential certainly being a strong flavour.”
As for the rest of Europe, German banks have been active, but not on their home turf. Commerzbank made the news by selling the UK operations of Eurohypo, its property lending arm, to Wells Fargo and private equity group Lone Star in a deal worth £4bn. The US bank will take control of £2.7bn worth of performing property loans, mostly secured against London office and retail property, while the private equity group will take on £1.3bn worth of distressed debt.
There has been little activity in Germany itself, with a new survey – State of Real Estate Financing and on the Distressed Real Estate Debt Situation in Germany – showing that the number of NPL real estate loans that will come to the market will not be as plentiful as expected (see The tide remains out’). Conducted by the research centre Distressed Real Estate Debt, which is jointly operated by Corestate Capital and the Real Estate Management Institute of the EBS University for Economics and Law, 60 chief executives, chief financial officers and managing directors from 32 commercial real estate financing institutions were polled. Banks that participated had total assets of about €2.56trn, or 72% of all the assets of German commercial real estate financiers.
According to Ralph Winter, founder of Corestate Capital, “The present opportune interest rate is certainly one reason for the low number of distressed real estate portfolios currently 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 non-performing loans has decreased.”
“It is a difficult scenario in Europe,” says Harin Thaker, chief executive officer at Aeriance Investments. “The low hanging fruit has been delivered, and banks are taking their time to sell the poor quality assets. They need to improve their balance sheets, so want to ensure they get the right price. They may wait for the economy to further improve.”
The impending asset quality reviews (AQRs) may also add some pressure, according to Graham Martin, global leader in the portfolio solutions group at KPMG. “There has been a huge uptick in activity over the past 12 months in the UK, Ireland and Spain, but I think we will see more sales from banks in other countries once the European Central Bank conducts its asset quality reviews. This combined with Basel III, will force them to look at their balance sheets because they will be penalised for holding risk-weighted assets.”
Launched in November, the ECB review, which will take 12 months, focuses on the underlying quality of assets on euro-zone banks’ books. There is a particular focus on real estate as well as SME lending, shipping and ‘legacy’ assets spanning pre-crisis derivative portfolios and leveraged loans. Although, investor sentiment towards the region’s banks has significantly improved this year, there is still widespread scepticism about the credibility of capital ratios that compare improved equity levels with still questionable asset valuations. Bank will be forced to review valuations and provisioning as well as assess their liquidity needs and this could lead to asset sales next year, according to Morgan Stanley analysts.
While Europe seems to have generated the most attention this year, Philip Cropper, executive director of real estate consultants CBRE, believes that Japan, the world’ third-largest economy, may be the next country to watch. “We have not seen a huge amount of activity but there has been a pick-up and that could accelerate next year due to prime minister Shinzo Abe’s economic policies which could result in banks beginning to liquidate their portfolios.”
Domestic funds such as Secured Capital, the real estate unit of private equity firm PAG, are already jockeying for position in the hope that the government’s monetary easing, increased spending and structural reforms will lead to an improved economy. In November, the group raised $1.5bn (€1.1bn) for investments in Asia, although it is specifically targeting distressed real estate and debt opportunities in Japan.
Overseas firms have also been sniffing around but they may have a harder time gaining entry if Lone Star’s recent experience is anything to go by. The US-based firm beat tough competition to be selected by a government committee as the preferred bidder to buy Osaka Prefectural Urban Development for ¥78bn (€55m). However, the deal was blocked by the prefectural of Osaka, raising concerns over the treatment of foreign investors, especially private equity groups. The industry has been widely criticised in the past as running vulture funds and while the stigma may be dissipating for local players, it still seems firmly attached to those with origins in the West.