Allan Saunderson (far left), Managing Editor of Property Investor Europe, discussed financing options for commercial real estate with a panel of experts at the ULI Germany Urban Leader Summit: (from left) Gerard Groener, CEO of Corio; Marc Mogull, founder of Benson Elliot Capital Management; Kay Ullman, investment manager for Patrizia; and Jon Zehner, head of capital markets at LaSalle Investment Management.
The entry of insurers and pension funds into European commercial real estate credit will have a substantial impact on property pricing, according to panelists at a the ULI Germany’s Urban Leader Summit, held at Deutsche Bank in Frankfurt in June. However, panelists could not reach agreement on whether non-bank lending can grow enough to replace a substantial portion of European bank debt.
Gerard Groener, CEO of the Netherlands-based listed-retail group Corio, pointed out that equity financing of commercial real estate is impossible while share prices remain hugely discounted. Other negative factors include discord over bank restructuring, new regulation, and worries about Eurozone stability, he said.
“The biggest opportunity in real estate in the world today is to invest in real estate debt in Europe,” said Jon Zehner, global head of capital markets at LaSalle Investment Management (LIM). LIM is already allocating its first fund, a £250 million ($385 million) UK vehicle, investing in “core mezzanine.”
"Given the quality of assets…and the pricing, we think you can earn very nice double-digit returns with…significant downside protection,” Zehner said. “We think it is a nice space [with] a lot of opportunities." But he said the group is in the early stages of thinking about how to take full advantage of the CRE credit opportunity.
Marc Mogull, founder and managing director of London private equity group Benson Elliot Capital Management, is not so sure that insurance groups and pension funds can move into European CRE lending far and fast enough to take up the slack from bank cutbacks. "For central bankers, if they come out of this crisis with one thing, it's going to be to shrink the size of the European banking sector compared to the size of the economies in Europe," said Mogull, who is also an adviser to the Bank of England.
“The issue of what replaces the banks is one that troubles me greatly in the short term,” Mogull continued. “If you look at all commercial real estate debt in Europe, something like 99 percent is held by commercial banks, plus a little part in CMBS. The last 1 percent is the debentures, the Corio borrowers, the non-banks—very small. So the notion that the 1 percent is going to save the 99 percent is not realistic."
Mogull addressed two other factors thwarting the CRE finance picture. "With Solvency II, every time we think there is some positive news, the regulators move in the other direction,” he said. “The second issue is that the people who want to come into the market today want to lend on product that is generally not where we really need the debt—and they want to lend in a form that most people don’t want to borrow."
Banks lend floating-rate debt, hedged even as short as three- or five-year terms. But non-bank investors mainly want long-term, fixed-rate debt, backed by high-quality assets, with penalties for prepayment.
One asset type for which there is plenty of lending demand is German housing, said Kay Ullmann, an investment manager at the German residential group Patrizia.
"If you look at the performing German residential space, there is a significant demand from pension funds and insurance companies to offer long-term debt," Ullman said. "That is a space where the 1 percent stands a good chance of replacing the 99 percent. I could imagine, over the long run, that the proportion of pension funds and insurance [firms] lending in that space could go up to…even 40 percent of total."
In the general market, Groener does not see any upturn from the current sluggish conditions before year end. Transactions are low and most listed companies are trying to lower leverage and cut risk. "If you want to take advantage of opportunities and keep your leverage in place while the equity is at a discount you can only do that by recycling your capital," he said. "That’s what most companies are trying to do now—trying to sell off things. This is a challenging market."
"As a company, if you depend on bank loans you are in trouble,” Groener added. “Ten years ago we mostly depended on bank financing, and now that tendency is close to zero. We only use bank financing for flexibility reasons if there is an overdraft facility there." Most Corio external funding comes from issuance of private corporate bonds. He said the firm will concentrate on investing or refurbishing retail and shopping center space in downtown, transit-oriented areas or large communities.
Zehner and Mogull agreed that, eventually, European CRE financing will disintermediate and become more diverse, looking more like that in the U.S.
“The more interesting question is how that disintermediation is going to happen,” Groener said. “The CMBS market in the U.S. is alive—just—but not alive in Europe…. There is still a place for some banks to syndicate deals. But a lot of companies are trying to fill that space and I hope they succeed because the hole is quite large."
Reprinted with permission from
Property Investor Europe .