As a result of the sovereign debt crisis in the Eurozone, financial institutions are trying to raise additional equity through asset sales. Distressed assets are the consequence of this trend, and they will shape the real estate investment environment in Europe for the foreseeable future. Opportunities will present themselves over the medium term, particularly in markets “where there’s more pain,” says Marc Mogull, founder of London-based private equity real estate group Benson Elliot Capital Management, and ULI’s U.K. chair.
“The distress that’s going to happen over the next year or two is because there are going to be more sellers in the market than buyers. It may be banks that are foreclosing, but it may just as well be borrowers who get the phone call from the banks that says, ‘When your loan matures in six months’ time, don’t count on it [being refinanced].’ ”
All asset classes will come to market, although German offices in poor locations could provide a distinctive investment target. Mogull says: “The assumption is that the Eurozone and the U.K. will see negative GDP growth—that’s not going to be good for fundamentals. However, Germany will probably be the tallest midget, as far as growth issues are concerned.”
The environment today is far different than it was 12 months ago: banks need to shrink their balance sheets, which means their appetite for lending is reduced. “What has changed is that a lot of those leases that were funded at seven or eight years are now one- or two-year leases and we’re in a very tough occupier market, so cash flow streams are eroding and capex [capital expenditure] issues are emerging. At the asset level, there’s a whole lot more headache than there was, and given that many of these deals are underwater or the refinancing prospects look weak, neither the equity nor the bank is comfortable putting up [or willing to put up] any money,” Mogull explains.
He says he expects “a lot of stuff that is going to be trading out [to be] debt, not equity. Given the choice, the banks will do two things before they sell the real estate: they will sell the loan because it makes their life easier or they will put pressure on the existing borrower to put the asset up for sale or cut a deal with a new financial backer. The situation where the bank actually forecloses and sells is the least common.”
All of these scenarios have risks associated with them. “The first thing is buying out of administration, [with] the most obvious risk being it’s very difficult to get anything resembling reps and warranties. If you’re buying debt, you have the whole challenge of getting to the asset. Even if you’re doing a deal with an existing owner [who] is underwater, that creates a new set of risks—i.e., what is a joint venture going to look like; how are you going to deal with control issues; what about conflicts of interest?”
Despite greater pressure on the banks to act, the market is not likely to see a flood of distressed assets. That said, “it’s clear the banks realize that the value outlook for anything but prime assets right now is negative and that has a real impact on their decision making. Once you have owners of property [who] believe that, they’re much more motivated to find a way to move things than if they think the reward for inertia is a higher price tomorrow,” says Mogull.