Editor’s Choice: The return of the unicorn

It takes a brave person to advocate a contrary view to Blackstone’s global head of real estate Jon Gray.

That’s exactly what Daniel Mair, partner at EY’s German restructuring practice, did earlier this week at PropertyEU’s debt finance investment briefing at the Opernturm office of UBS in Frankfurt. Responding to a comment made by Gray at INREV’s recent annual conference in Barcelona that Europe is now past the distress phase, Mair modestly started his response by saying: ‘Who am I to disagree with a player like Blackstone?’ He subsequently put forward a convincing case for why Gray’s statement does not apply to Germany.

Pointing to Germany’s bad banks FMS, EEA and some of the landesbanks or regional lenders, Mair said: ‘I don’t think the distress is gone in Germany. A lot of distressed assets have not been hitting the market yet. So far this year, we have seen the first tranches of large distressed debt coming to the market, so it’s a little premature to say that distress is over in Europe.’

The German market has dealt with its distressed assets more slowly than the UK, Ireland or Spain in a bid to retain a measure of stability and much work still remains to be done to restructure loans that have turned sour, he continued. ‘We haven’t worked through it all, there is more to run, very much so. For 10 years I have focused on the real estate space and NPLs and I have never seen money this cheap. Our team is working on a number of acquisitions and disposals. It is a pretty good time to be an advisor in this segment.’

Lending landscape is not homogenous
Mair’s comments are a fresh reminder that cultural differences permeate the European landscape and that individual countries operate at varying speeds. To be sure, Europe’s real estate financing landscape is becoming more diversified as alternative lenders increase their share of the market, but the picture across Europe is anything but homogenous. The drive to alternative real estate lenders is particularly evident in the UK, where local banks accounted for 72% of lending prior to the global financial crisis, the briefing learned. Since then the proportion has halved to 36%.

Alternative lenders have also increased their presence in recent years in Ireland and Spain, where traditional bank lenders were hit particularly hard by the crisis and subsequently cut back their lending. But the same is not true for Germany, Paul Dittmann, head of commercial senior mortgages at M&G Investments, told the audience. ‘Germany has a strong Pfandbriefmarket and that has kept out alternative lenders,’ he said.

And although insurance companies and non-bank lenders now account for 23% of real estate financing in the UK, even this market is still far away from the more balanced lending landscape prevalent in the US where just under half of all real estate finance is provided by alternative sources. Moreover, the US model is far more firmly entrenched: the banking sector currently accounts for just over half of all real estate lending in the US and that has been the trend for the past 50 years.

Chinks in the German bastion
The picture across the Continent is far more diffuse, especially in Germany where traditional lenders still have a strong grip. But although Germany is likely to remain a bastion for local financiers, speculation about chinks in its banking fortress has started to surface. So far Asian financiers have not made a big splash in either the UK or Europe, but that could change further down the track, Anthony Shayle, MD and head of global real estate and UK Debt at UBS, noted.

One potential new source of real estate finance is Japan where margins are currently very thin, he said. But the Japanese tend to be ‘very slow, meticulous and methodical’, he added. Shayle is more upbeat about potential debt sourcing from China. ‘A lot of money is coming out of China,’ he pointed out. ‘This is definitely an area we should look at from a long-term perspective. The Chinese could take a front seat if short-term money disappears from Europe.’

So far Asian banks have not yet been sighted in Germany, EY’s Mair reported. But Chinese real estate financing is definitely a topic for the next 10 years, he agreed. ‘There are Chinese investors in London and Paris, and now Frankfurt and Berlin. Given the portfolio investment approach of Asian money, I’m surprised it hasn’t started yet...we’re still waiting for them to come in.’

Chinese funding could potentially land in Germany via a new wave of M&A. Earlier this year, it emerged that Hypo Real Estate Holding (HRE) is gearing up to divest its entire stake in pbb Deutsche Pfandbriefbank or to exit via an initial public offering. A sale could provide an opportunity for a Chinese bank, Mair said, but added that a Chinese pitch could throw up some political obstacles.

Just this week media reports surfaced that Anbang Insurance Group of China is in talks to buy pbb in a deal said to be valued at €1.5 bn. It is not the only name being bandied about: US private equity firm Blackstone Group is also said to have expressed an interest in Pbb.

Syndication makes a comeback
Clearly, Europe’s real estate financing landscape is in a state of flux as syndication makes a cautious comeback and senior debt funds become a standard feature. But the wide lending margins that attracted a new wave of alternative real estate lenders including insurers and dedicated debt funds in the aftermath of the global financial crisis have narrowed considerably in the past three years.

To quote Shayle of UBS, the ‘super profits’ that lenders experienced in that period have eroded away as lending margins have come down. Average margins for senior debt are now around 3.5% compared to 5-6% in the peak years while margins for mezz debt have come down too, he noted.

Not surprisingly, both traditional banks and alternative lenders are now moving up the risk curve. Alternative lenders are starting to differentiate themselves by going into the regions and both the banks and alternative lenders are staking out development and spec development financing in their search for higher yields. The returns can be good but it is not without its risks and dangers, Shayle noted. ‘The crucial question is whether the underlying real estate markets are understood.’

In other words, only lenders with a deeper understanding of actual physical structures can justify or validate the narrative of a developer.

An equally important message is that development finance is no longer a rare beast. Or, as Shayle himself put it, it not gone the same way as the dodo. 'Fortunately, it has not proved to be a unicorn.'

Judi Seebus
Editor in chief