The flow of distressed loans and assets in the European real estate market is slowly making its way through the system, but there is still a long way to go, according to Ric Lewis, CEO of Tristan Capital Partners.

The flow of distressed loans and assets in the European real estate market is slowly making its way through the system, but there is still a long way to go, according to Ric Lewis, CEO of Tristan Capital Partners.

‘The size of the potential assets - the loans that need to be refinanced and the assets that are on banks’ balance sheets – is huge compared to the amount of capital. But it hasn’t all surfaced yet in the marketplace and if you look at what’s out there plus the capital that’s out, I think there is a relative equilibrium. It’s still a good buyers' market.’

Lewis compares the current opportunity in the European market to ‘a huge elephant trapped in a snake’. ‘If you look at the amount of capital to take that out, it is underwhelming compared to the trapped opportunity, but we’re only starting to see that elephant emerge from the snake now. That’s great because that will mean that price appreciation doesn’t run rampant because there is enough assets flowing into the system for people to invest in.’

SOUTHERN EUROPE
While a new wave of opportunistic investors, particularly from the US, is flocking into Spain, Lewis remains cautious on Southern Europe. ‘I think the recovery in southern markets is very capital markets-led. Our first position is that there is plenty of distress, but I’m not sure if it’s all distressed opportunity. There has been a big capital markets response to a very small positive change in GDP growth. Or to put it differently, the rate at which the knife has been falling is only slowing down.’

In some southern European markets, significant appreciation in prices and investment activity is not supported by improvement on the ground, he added. ‘I see that rents have stopped falling, vacancy rates have stopped increasing, but grocery prices are still falling in Spain. They may be levelling out, but on the ground stores are still evaporating even if some of the bigger chains are taking advantage of the situation to buy market share. I would exercise caution because I think the headlines are ahead of reality. ’

Nevertheless, Tristan has recently become more active in Spain and Italy, Lewis conceded. The focus is on assets with the potential for institutional appeal that are liquid but need fixing, he added. ‘But we have a guarded viewpoint. We don’t want to rely on yield compression, we want to rely on asset management.’

ELEPHANT AND SNAKE MACHINE
At the same time, excessive price appreciation is a potential risk that could create a new disequilibrium, Lewis noted. ‘I’m a little concerned, we’re at the early stages of capital formation and I can already see the effect on pricing. Because there’s so much capital out there for how much is actually surfacing out of the snake. As long as more things keep moving out of the snake - and they should - the machine will continue to work. Because with that little bit of price appreciation, what we’ve seen is that we’ve got closer to the clearing prices of the banks so they can afford to take more things off their balance sheets. When prices go up closer to their exit price, they can move more of the dead bodies to the market, more of us get to buy those assets, reform them, renovate them and fix them. That’s how the machine needs to work.’

In contrast to the US where the bailout for distressed banks involved bank losses being offset through the TARP programme and its successor RTC, European banks are dealing with their problematic loan portfolios on their own, Lewis pointed out. ‘It’s nice that the equilibrium has come back to move the stuff. But we’re well way from the financial crisis moving through the system. There’s still a tonne of stuff, a huge amount of assets, that has to find other hands in this cycle. Even if we start to see a near-term movement in prices, there’s still a long road to travel before we’re through the aftermath of the crisis.’