Debt buying REITs ‘could ease bank deleveraging congestion'
By James Wallace - Thursday, December 01, 2011 15:00
The potential introduction of legislation for mortgage REITs, which would allow the sector to buy commercial real estate debt and CMBS bonds, would provide a fillip for banks’ efforts to deleverage.
There is a heightened need for banks to unwind their real estate balance sheets, driven by a combination of factors, including EU-imposed deadlines for a number of eurozone banks to be sold in the next two years – notably Eurohypo, Deutsche Pfandbriefbank and West Immo – as part of conditions attached to accepting State Aid.
These long-standing deadlines, together with the worsening eurozone crisis, a deteriorating economic outlook for the next two years and increased bank funding costs causing palpable fears that the global economy descending into a second Credit Crunch, is restricting new lending at a time when the wall of UK real estate refinancing over the next 24 months reaches more than £100bn.
All of which makes the case for mortgage REITs compelling, bankers, analysts and property investors argue.
Next week, the Treasury is expected to update the property industry on changes to REIT legislation. Back in October, the Treasury announced that the 2% conversion charge to REIT status will be abolished as part of next March’s Budget.
New REITs will have three years in which to satisfy the diverse ownership test, which states that the largest five shareholders must not control more than 65% of the shares. These changes are likely to make REITs more attractive to investors and attract capital into UK residential and commercial property, experts say.
The government is still thought to be seriously considering bringing in new legislation to create mortgage REITs, which would provide tax exempt status on income from debt interest or on capital gains from debt sales.
Mark Nichol, analyst at Bank of America Merrill Lynch, said: “This could help to attract capital to CRE debt, provide an exit for banks to sell their legacy loans, and help stimulate new lending in the sector, in our view. Mortgage REITs are not proposed for the 2012 Budget, but could be implemented in 2013 if it goes ahead.
“Mortgage REITs could be buyers of legacy CRE loans from banks. This additional demand could help improve the recoveries banks are realising on their NPLs. So far, such loan portfolios are being bid at discounts of 40% or more to the nominal loan amount.
“It is unclear where equity investors would price the equity in mortgage REITs, but assuming their equity return targets are lower than roughly 15% required by the current bidders – Cerberus, Blackstone, Apollo, etc., this could also improve recoveries for banks, which could facilitate more disposals by the banks.”
The British Property Federation said while there is little clarity about what Mortgage REITs might actually look like there are a range of possibilities which could be explored.
The BPF said these include: allowing existing REITs “to buy property debts within the ring fence; property finance specialists could form new pure mortgage REITs to acquire and manage existing property loans originated within the banking sector; or MREITs could be allowed also to originate commercial property debt, creating a new, specialised source of property finance that could increase the flow of finance to the property sector from outside the banking sector”.
Nichol added: “Mortgage REITs would also be permitted to buy CMBS. Legacy and new issue CMBS could be a natural fit for mortgage REITs. Legacy for the attractive yields available relative to whole loans, while new issue would give the mortgage REIT greater flexibility, via the tranching, to invest at a particular risk/reward target compared to being limited to whole loans or mezzanine loans.
“This potential new investor base for CMBS could become an important stimulus for new issuance, although it would remain to be seen where the equity would come from for the REIT and at what required return, and similarly, whether the REIT could attract leverage and at what price.”
jwallace@costar.co.uk