Lending markets are on the move again, helped by the emergence of new sources. Rising inflation should force the hand of the banks, but refinancing remains a huge challenge, exacerbated by Basel III, says Rudolf Molkenboer
The depth and duration of the financial crisis we've just experienced had a severe impact on real estate financing worldwide and shattered the prevailing assumptions and relationships that had driven the increasing globalisation of financing bricks and mortar. Many major players have left the market and financing practices have been put in question as they failed in the face of excessive leverage.
Now, however, a new financing landscape is beginning to emerge, which will be dominated by a different line-up of participants taking a more conservative approach and with the consequence of higher costs for the market. I also believe, crucially, that real estate investment remains sufficiently attractive and that innovation by financers is still of a high quality, so that we will be able to meet the huge challenge of refinancing left in the wake of the crisis.
The picture across the world remains mixed; with the exception of a few international financers such as ourselves, there is a general pull-back from globalisation to a focus on regional markets. Investment banks as a group have more or less abandoned the real estate lending sector.
Business is picking up again in the US via the activity of a few large general banks, such as Wells Fargo, Bank of America and some regional players. New transparent commercial mortgage-backed securities (CMBS)structures with lower loan to value ratios are also proving competitive on larger retail mall deals in the US.
In Asia-Pacific, Chinese banks are flush with cash and Australian banks are well capitalised and have ample liquidity for real estate lending.
In Europe, a notable recent feature has been the retreat of some German banks from international property lending, which is probably linked to a need to rebuild their equity cushions in anticipation of Basel III capital requirements. Irish banks are of course facing their own challenges.
DTZ estimates Europe's real estate refinancing gap to be €145bn, and while some of that may be temporarily relieved by the permitted two-year extension in CMBS maturities, these represent only about 15% of the European market, leaving a huge challenge still to be met.
As the tug of war between inflationary and deflationary forces seems to be moving in favour of the former, we may see interest rate rises coming through sooner than expected this year. This would end the ‘pray and delay' tactics of banks and investors avoiding marking valuation losses against their balance sheets, as rate rises cut into their cash flows, and might finally clear the logjam in secondary investment markets. There are clear signs of investment funds gathering capital for so-called ‘core/core-plus strategies' aimed at assets in the top-end of secondary markets as the market clearing exercise gets underway.
Large insurers targeting real estate loan markets through new funds are a fresh source of financing in Europe, although this is a well-trodden path in the US. Alternative investment funds by way of mezzanine and junior loans are also preparing themselves to step into the marketplace provided the entry price is attractive. Junior financing is, step by step, being reinstated as a tool in large refinancings.
We expect the bond markets for commercial real estate investors to also play a more important role in both the European and US financing markets, as these are one of the few financial instruments to have sailed through the crisis with their reputations enhanced in the eyes of regulators. While the bond market is relatively small in Europe, with an average issuance of about €5bn from mostly larger listed real estate companies in the Netherlands, France and the UK, it offers a competitive option to smaller quoted property firms and non-listed funds.
Banks are increasingly willing to lend to club deals, and ING REF itself is seeking more underwriting opportunities. Underwriting deals of up to €200m are achievable in Europe and final stakes of €70m are not a problem compared with a level of maybe €50m a year ago.
In conclusion, the real estate investment and financing markets should be prepared to be able to accommodate the forthcoming adjustment in secondary market valuations, probably triggered by rising interest rates. There will be, in all likelihood, capital available from varied sources to meet the demand, but tighter supply will inevitably mean this will come at a higher cost than borrowers were accustomed to in the recent past.