Germany’s leading lenders have managed to underwrite a sizeable amount of new business this year despite increased competition in the market, writes Sara Seddon Kilbinger.
Despite the recent boom, German lenders are faced with an unwelcome truth: the country's debt market is shrinking. And, as commercial property transaction volumes tumble, lenders are being forced to vie for an ever-smaller slice of the lending pie.
'The transaction volume has decreased significantly, largely due to a lack of supply rather than to decreasing demand,' says Thomas Köntgen, deputy CEO, treasury and real estate finance at German lender pbb Pfandbriefbank. 'This makes the market even more competitive for lenders.'
Transaction volumes in Germany plummeted 25% in the first half of 2016 to €18 bn, according to JLL. In addition, the aggregate commercial property loan portfolio in Germany has fallen by 14% since 2010 to €261 bn at the end of last year, according to the VDP (association of German pfandbrief banks). In addition, the problem is compounded by the fact that although the German property market recovered well after the financial crisis, it is becoming increasingly difficult to invest capital due to reduced investment opportunities which, subsequently, means that many investors are simply taking on less debt, according to Dirk Richolt, managing director and head of real estate finance at CBRE in Frankfurt.
'If you have a lot of capital and can keep a deal unleveraged, why wouldn’t you do that as an institutional player?' he says.
As a result, Germany is in a 'unique situation', according to Michael Kröger, head of international real estate finance at Helaba: ‘Prices are at a high level. A lot of investors don’t want to sell because then they have to find something else to reinvest that capital in. Investors are taking on less debt because they just don’t need it,’ he says.
German lenders, particularly alternative lenders, have also become less active in the past year because 'they are driven by absolute returns', Richolt adds: 'Most insurance companies find it difficult to invest in illiquid bespoke investments like CRE mortgages if the absolute return is below 2.5% to 3% and, due to the steepness of the yield curve, they stick to very long dated debt,' he says.
'Bank funding has become a lot more efficient since 2013 with cheap funding from the ECB and credit spreads for banks normalising,' he adds.
Margins on longer term loans set to rise
However, there is some good news for lenders: after several years of shrinking loan margins, the unthinkable has happened: loan margins on longer term loans of around 10 years or above are actually increasing, according to Roland Fuchs, head of European real estate finance at Allianz Real Estate.
'We could see an increase in loan margins, particularly on very long-term loans. That could be a trend going into next year,' he says. Kröger agrees: 'While the loan margin can vary, depending on the asset and location, you can generally expect loan margins of around 150 bps or more on longer-term loans of up to 10 years.'
This could be a 'breaking point' for pension funds and insurers, 'who have found it hard to achieve the minimum return', Richolt adds.
Germany's lending market has stabilised in the past year, according to Fuchs, who describes it as 'very broad, liquid and very competitive': 'The main difference since last year is that loan margins have stabilised at around 80p bps to 120 bps on prime assets. That means that the downward trend has stopped.’
Nonetheless, the environment is challenging, says Assem El Alami, head of central sales and foreign business at BerlinHyp: ‘There’s a lot of liquidity in the German market but the pressure on margins is pushing banks to the limit of what they are comfortable with. We want to avoid high risk situations.'
Opinion divided as to whether Brexit will affect German lending market
Analysts and investors remain divided as to whether the Brexit vote will have an impact on Germany’s lending market. For some real estate experts such as Hubert Keyl, head of C&W’s Munich office, the Brexit could actually have a beneficial impact on Germany’s lending market: ‘We already see more capital making its way to Germany rather than to the UK since the Brexit vote,’ he says. ‘More investment also means more loans. We have already spoken to investors who have said that they want to invest in Germany instead of the UK because of the Brexit.’
Richolt, for his part, does not expect the Brexit to have a major impact on the German lending market. ‘However, with regard to the UK, German banks will carefully evaluate if office demand may truly be impacted and adjust lending policies accordingly,’ he says.
Köntgen is also sceptical that other major European hubs, including German ones, will benefit from the Brexit as much as they hope to: 'Developers in all major European cities argue that their cities will benefit from a Brexit – which is nevertheless highly unlikely.'
Lenders still banking on UK post-Brexit
Some German lenders are eyeing the UK more favourably, following the vote in June to leave the EU. One such lender is Allianz Real Estate. 'We see opportunities on the lending side there, due to the price correction and weaker sterling…so we certainly aren’t excluding underwriting further loans there,' Fuchs says.
For other German lenders, it is business as usual in the UK, irrespective of the vote to leave the EU. 'The vote has no immediate impact on our business – apart from increased volatility in the markets,' says Christian Schmid, managing director of business and syndication management at Aareal Bank. 'We will be maintaining our activities there without any changes. However, we will be keeping a close watch on further developments. Even if the exit process takes some time and it is currently not possible to say in what form the EU and the UK will cooperate, we are confident that the UK will remain an attractive market for Aareal Bank both in the medium and long-term.'
Pbb will also continue to do business in the UK, albeit on a 'careful basis', Köntgen says. 'We expect the UK to remain a core market for pbb. As far as our existing loan book is concerned, we see only limited downside risk.'
However, while German lenders are still active in the UK, they are no longer driving the debt market like they were last year, according to Edward Daubeney, director, head of debt advisory at Cushman & Wakefield in London. 'Since the Brexit, they have taken their foot off the gas and are waiting to see what happens next,' he says. 'Nobody really knows by how much values could fall but by the end of this year, I think a line will be drawn in the sand and we’ll have a better idea.'
Other German lenders are considering dipping their toes back into the UK. BerlinHyp stopped lending in the UK in 2012 but is now eyeing it with renewed interest, El Alami says. 'We are observing the UK market following the Brexit vote and we are considering re-entering the market. However, refinancing there will not be easier because it is affected by the volatility,' he adds.
Loan books swell, despite weaker climate
German lenders have managed to underwrite a sizeable amount of new business this year, despite increased competition between players in the market. One of the most active lenders, Aareal Bank, underwrote €4.4 bn in loans in the first half of this year, including extensions, according to Schmid. The bank's target for 2016 is €7 bn to €8 bn, down slightly on the €9.6 bn generated in 2015.
Pbb Pfandbriefbank was one of the few lenders to generate more business in the first half of this year than last year: it underwrote €4.5 bn in new loans and extensions in the first half of 2016, of which the German market accounted for 50%, according to Köntgen. In the first half of 2015, pbb underwrote €2.5 bn of loans. It has not disclosed a target for the full year.
Helaba underwrote €4.9 bn of loans in the first half of the year and is hoping to grow that to €7.8 bn by the year end. BerlinHyp underwrote €2. 9bn.
More lenders finance outside 'big 7' cities
A growing trend this year is increased competition forcing lenders to be more flexible, according to Keyl. 'B and C cities are becoming more transparent which, in turn, means that it is far easier to get financing for properties in those cities than it was a few years ago. Banks have woken up to the fact that there is a lot of potential there.'
BerlinHyp will lend in B and C cities, according to El Alami. ‘Everyone is looking for yields but they can be sub-5% or even sub-4 % in Germany's 'Big Six', so everyone is looking for alternatives. It’s a feasible strategy but it does also depend on the ticket size. Deals are smaller in smaller cities and the markets are more illiquid.'
Challenges ahead
Competition in the market is unlikely to abate soon, says Richolt, noting that the next round of regulation is going to reduce profitability further 'because the capital requirement for CRE lending will increase, banks are vying for new business as it’s the least bad thing they can do in a negative interest rate environment,' he adds.
Others, such as Köntgen, maintain that the transaction volume is unlikely to fall further over the next 12 months, which will boost the lending market. 'GDP growth of around 1.5% (in line with the European Commission forecast of 1.6% for 2016 and 2017), should be sufficient to support the real estate market in Germany.'
Tensions in Europe are also affecting Germany, El Alami says. 'On the fringe of the market, there is some tension over issues such as the NPLs in Italy. There are variables which can change the game quite significantly.'
Lenders are divided as to what extent bad news elsewhere could ricochet out to Germany. For Keyl, negative news elsewhere is likely to solidify Germany's position as a safe haven, he says, also citing Italy's ongoing NPL crisis, which is undermining the local economy. It is estimated that Italian NPLs total around €360 bn, which equates to 18% of total loans or one sixth of Italian GDP. The Italian government would struggle to rescue its banks even if it was allowed to do so under the eurozone’s new Single Resolution Board.
However, other lenders fear that the Italian crisis could trigger a chain reaction across the European banking system. 'If the Italian NPL numbers turn out to be true, it would have a substantial impact on European lending markets because the access to capital markets would become harder. Funding would, therefore, become more expensive. It would have a very negative impact on a European level,' Kröger warned.
