BLOG: Greed will overcome fear

Debt will follow equity and eventually move into secondary real estate locations, ULI's Trends Conference in London heard last week.

Jim Garman, managing director of Goldman Sachs, was somewhat reluctant to give his view on how the real estate financing landscape may shape up in the next five years during the final round of a panel discussion on the topic at the ULI Trends conference in London last week.

His hesitation was followed by a confession that he had thought somewhat too lightly about HSBC’s mark-down of its sub-prime portfolio in February 2007 when asked whether it could have wider ramifications. At the time, Garman had answered that he didn’t think there would be any big problems.

Given Goldman Sachs´ role in the run-up to both the sub-prime and the European sovereign wealth crisis, not to mention the performance of its property funds in recent years, it is hardly surprising that the investment banker has gone quiet since the outbreak of the financial crisis. Garman is also to be applauded for showing some reticence after his clear lack of foresight in February 2007.

But following further prompting by his peers at the ULI conference in London, he did finally speak out further on trends in the European real estate financing market. The funding mix will change and there will be a migration to CMBS, he predicted. The CMBS market in Europe was little more than a fledgling at the outbreak of the crisis, certainly compared to the US, and has since virtually shrivelled up altogether following huge markdowns on loans syndicated during the boom years and losses by the loan holders.

CMBS makes a comeback in Germany
In recent months, however, there have been signs, particularly in Germany, that the financing instrument may be making something of a comeback, albeit in a more simplified form following widespread complaints that the vehicle lacked transparency and had become too complex. But with banks retreating from the real estate lending market, conditions have changed, Garman alleged. CMBS will grow again out of necessity, he said. ‘Now we do need a CMBS market, we didn’t before.’

Appetite for CMBS is growing, John Feeney, global head of corporate real estate at Lloyds Bank, confirmed. Increasingly, pension funds and insurers are joining banking syndications for CMBS and every issuance draws in excess of 20-odd investors even if the ‘goliaths’ are the ones taking up the bulk of the issuance. Nevertheless, there is still a long way to go, as Jon Zehner, global head of client capital group at LaSalle Investment Management, pointed out. His comparison with the US puts the European picture clearly into perspective. In 2012, CMBS in the US accounted for £46 bn and is growing further this year, with almost £36 bn recorded as of end-June. But although this is still a fraction - or just 20% - of the figure at the peak in 2007, it still compares very favourably with Europe where just a handful of securitisations has been issued to date.

Overall the conclusions of the panel discussing the future of banks and the implications for real estate were hardly upbeat. Last week, UK chancellor George Osborne revealed that real estate finance was the only sector that would be restrained as regulators continue to grapple with the fallout from the financial crisis, William Rucker, chief executive of Lazard London, told the conference. Coming from a situation where banks are much riskier and more volatile, it is hardly surprising that regulators want them to be dull again instead of casinos, he added. ‘The banking system is pretty sick and it’s not about to get better. Continental banks in the main haven’t faced the music and marked (their loans) to book.’

Healing gets under way in UK and Ireland
Having said that, British banks have healed first and have made massive strides in de-levering, he pointed out. Ireland is also well on its way to recovery, and has healed very quickly in the past 18 months, noted Feeney. But Ireland is relatively small, he added, especially compared to Italy and Spain. ‘Italy and Spain will take much and much longer.’

With a reduced role for banks and a greater focus on capital markets, the European real estate financing sector has a rocky road ahead of it, Rucker said. But there are a few positive signs. As banks continue to withdraw from the property financing scene, new players - primarily US lenders of the likes of Wells Fargo as well as insurance companies - are emerging to fill the vacuum. With the US Fed continuing to print money, US players in Europe are still able to benefit from a spread of 50-100 bps. No wonder then that every week another new US player arrives in Europe, Garman said.

Indeed, Goldman Sachs has also stepped into the vacuum. While the investment banker focussed on opportunistic private equity before the crisis, now opportunistic credit accounts for roughly half of its activities, Garman said. Nevertheless, the newcomers are not able to bridge the whole gap which is put at £20-30 bn for the UK alone. Nor is an even distribution of lending via banks, insurers and CMBS - with each accounting for a third of the total as in the US - on the cards anytime soon in Europe. ‘Alternative lenders will provide a piece of the puzzle, but it’s not enough,’ Garman said.

At the same time, commercial banks have not disappeared altogether, Feeney said. But, he conceded, their role is changing. Banks no longer use their balance sheets as the primary tool for doing business in the real estate financing arena, but rather their 'rich relationships' to match needs and spread generic risk, for example through syndication.
‘We bring our origination sourcing network, not just a big balance sheet...we have to be smarter.’

Lloyds itself is still active as the biggest real estate lender in the UK, he added. The focus is on senior lending, but Feeney also likes development. ‘If there’s a good credit story, there’s a capital market take-up story.’ But, he conceded, the senior level is patchy across the UK and the Continent. While there’s an oversupply of debt for prime assets and core locations, finance for riskier assets in regional UK and southern Europe is still scarce, he added: ‘In Germany there’s excess liquidity, but Southern Europe is a desert. There’s an increasing polarization between prime and non-prime in the north and south. More transparency is needed in the market for CMBS instruments. But in Southern Europe I don’t think transparency will be coming soon.’

Germany is indeed a case apart with fierce competition from local savings banks and national lenders, according to Michael Cochrane, senior managing director of Wells Fargo subsidiary Eastdil Secured. About 90% of financing is still conducted by commercial banks with a straightforward lending profile and the lending opportunities are limited due to very competitive rates. ‘It’s too competitive to come in.’ The US lender is, however, looking ‘very selectively’ at France, in particular La Defense, but Spain and Italy are not transparent, he added. The UK is the market of choice within Europe: ‘The UK recovered much quicker than its peers.’

Eventually, however, debt will also start to flow to secondary locations, predicted Lazard’s Rucker. ‘Equity is just beginning now, debt will move in after.’ On this point, Garman showed no sign of hesitation: ‘Greed will overcome fear,’ he predicted.