Real estate loan sales set to increase 'massively' in next 2 years

The European market will see ‘massively’ more commercial real estate (CRE) loan sales in the next two years, delegates at the ULI annual conference in Paris this week heard during an expert panel.

A number of ‘pretty tough’ deadlines loom on the horizon that will speed up the deleveraging process in Europe, according to Peter Denton, head of European debt at Starwood Capital Group. In order to comply with Basle III regulations, European commercial banks need to bolster a number of key ratios, such as the ratio of their capital versus their lending book and leverage levels. This may be done in stages by 2018, but a key intermediary deadline is 2015, Denton noted.

‘Most banks in Europe still don’t meet these ratios. Up till now, a couple of things have saved them. If they had all tried to mark their books to the right places, they would all be bankrupt - so there was a conspiracy of silence. But now banks have to get their books marked properly. That has massively increased the amount of loans that are being sold off to meet the deadline.’

The most pressing deadline is September 2014 when the European Central Bank takes over as regulator for the European banking system, he added. ‘The Asset Quality Review is a really big thing. It’s a moment in time that allows executives at banks to be honest. If they’re not, they might find themselves in deep trouble afterwards.’

Lack of liquidity
Lack of liquidity and the inability to raise new capital were also an excuse for previous inactivity, but that has changed, too, Denton said. ‘Now is an interesting moment in time, there is a capacity to do something, there is liquidity, high yield, corporate bonds and improving P&L accounts. In an improving world, there’s an ability to do things and some pretty tough dates are coming up. That’s creating real interest and changing the dynamics of what’s going on.’

While traditional lenders are still keeping a tight rein on new lending, increasing amounts of capital are coming into Europe from non-traditional debt providers such as insurers, debt funds and REITs. According to Joe Azrack, managing partner real estate at Apollo Global Management, two types of real estate lenders are currently putting out fresh money for real estate: ‘We’re seeing bond investors who are simply looking at the spreads, certainly in the US and increasingly in Europe. They’re just looking for a better spread than triple B or single A bonds, which is not a very high standard today based on where interest rates are. Then there are real estate investors, looking at something north of that, or something as high as a core or core-plus total return, call it mid to high single-digit yields. When you think about your financing requirements, it’s important to keep these two distinctions in mind.’

While a range of financing choices exist for fully leased buildings in European cities such as Munich or London with a 60% LTV, it is more difficult to find a lender for assets outside that category - which is precisely where Apollo and Starwood operate, Azrack said. ‘We’re real estate investors that underwrite risk and are willing to take additional risk for additional return on your investment. That’s a really big opportunity in Europe. Only a couple of years ago, you couldn’t find more than $100 mln in real estate loan underwriting, even in New York. But that has changed dramatically in the last couple of years.'

Asian and US capital
Azrack expects to see ongoing capital flows targeting Europe. 'We’re going to see more folks from the US or Asia, more innovative structures sponsored in Europe that’s going to fill that vacuum here. Because it’s going to take a protracted time for banks to recapitalise and to come back into the role they had before, particularly in the range for 50-60% LTVs for non-prime properties. That’s a very opportune area. We’ve invested about $4-5 bn in the US and we have some pretty big objectives for Europe.’

Summing up some of the key observations during the panel, Van Stults, managing director of Orion Capital Managers, said that ‘extend and pretend’ is now set to become a phrase of the past. ‘Loans sales will be increasing over the next couple of years, also from NAMA, which is currently about a third of the way through.’

German banks also have some unresolved issues, Olivier Piani, CEO of Allianz Real Estate said, adding that some were now taking action and embarking on loan sales outside Germany. ‘I don’t have the numbers for Germany, but we bump into them from time to time. The reason why we can’t buy such assets is that the market value is less than the loan. That means they remain frozen for a while.’

Long process in Germany
According to Starwood’s Denton, Germany’s two bad banks FMSW and EA together hold well over €500 bn in real estate loans. But Germany has adopted a very different solution to the problem than many other countries like the UK and Ireland, he noted. Resolving the problem in Germany is destined to be a 15-20 year process, he said. ‘They have metaphorically locked the door and thrown away the key. Arguably that has been helpful to German banks as it hasn’t created instability.’

While the creation of Spain’s bad bank Sareb has been helpful to recycling some of the loans in that country, buyers need to be aware of the risks, Azrack said. ‘There’s an awful lot of residential and land in non-performing loan portfolios. That’s a very different type of asset which requires different pricing, a different time horizon, underwriting and management skills.’ Zombie banks are also a risk: they account for ‘an awful lot’ of the Spanish banking system and it’s just a matter of time before they will be consolidated, he added. 'A lot of hot money is non-dedicated real estate investment. There’s a belief that there must be a deal there and that’s certainly affecting the pricing.’

There are risks in Spain, agreed Denton, who cited US hedge funds converging on the country. ‘There was a time in Germany between 2005 and 2006 when it was the best time in the world to sell if you were a German insurance company or a closed-end fund with something that you’d had in the locker for 20 years. It was the moment in time that you could do it. I sense there’s now a danger of a garbage clearance in Spain. The danger is a perception that you’re getting a bargain. There’s lack of appreciation of a process called concorso, which means that you can’t enforce a mortgage if the borrower is paying interest on the loan. If you end up in concorso, the enforcement process could take a reasonable amount of time.’

Deleveraging process has so far been slow
According to a recent CBRE report, there is currently still around €925 bn of commercial real estate debt across Europe. ‘About 25% of the debt outstanding before 2008 has been retired,’ managing director Van Stults of Orion Capital Managers noted during his introduction of a panel entitled ‘Which countries are really getting to grips with their CRE loans. ‘The deleveraging process is going on, but it’s a very different process across Europe.’

According to Olivier Piani, CEO of Allianz Real Estate, there are a number of fundamental reasons why European banks have been slow to sell off their commercial real estate bank loans up till now. We now live in a very low interest rate environment, he pointed out. ‘For a bank to own a non-performing asset is not a very costly exercise. That is very different to the previous real estate crisis 20 years ago,’ he added.

Another reason why banks have not been offloading their CRE loans on a large scale up to now is that they don’t have the capital to write down assets, he continued. ‘If they did, they would go bankrupt. That’s why they’re choosing to do it over several years. They have the perception - and it’s probably the right perception - that real estate is a cyclical business and that after a downturn there is a low point and then an upturn. They see no reason to sell at this point in the cycle.’

Government-backed rescues of commercial banks, particularly in Spain, the UK and Ireland, have provided traditional lenders with a backstop, Piani observed. ‘The (European) real estate crisis 20 years was a real estate crisis. Five years ago, it was a leverage crisis. Banks are not very well equipped to deal with a real estate crisis, but they are better equipped to deal with this one.’

The size of the deleveraging problem has also slowed down the process, noted Joe Azrack, managing partner of real estate at Apollo Global Management. While the European banking authority puts the capital deficiency in European banks at around €70 bn, Azrack reckons this is probably a low number and that the real figure may well be substantially higher than that, possibly as much as €200 bn. Offsetting such a huge writedown would require ‘gigantic’ capital raises, he pointed out. ‘It will take time and consolidation of banks, and/or economies will have to get better and asset prices will have to rise so that there’s not so much of a discount.’