IMN 2011: prolonged uncertainty to stifle debt markets
By James Wallace - Thursday, October 27, 2011 15:16
With the world’s eyes on Europe’s politicians today after finally reaching an agreement with private investors in Greek sovereign debt to accept a 50% haircut, the consequences for European real estate debt markets are palpable.
Since the summer, market visibility has been stifled by political and macro-economic uncertainty eroding investor appetite – for buying and lending – which has reduced liquidity and, ultimately, property fundaments. If the market trips back into recession and employment levels contract, the occupier market will suffer, deepening concerns for real estate markets.
There is now no doubt as to what was at stake this last week, with many calling Greece “Europe’s Lehman Brothers” in that if it were allowed to fail, as the US Federal Reserve did for the once fourth largest investment bank in the world, the consequences would have been a financial tsunami unstitching fragile banking markets – the lifeblood of property markets.
So it was no exaggeration when Angela Merkel, the German chancellor, said earlier: “The world had its eyes on us today.”
Europe’s private equity markets real estate gathered this week for a two-day event hosted by IMN at London’s Landmark Hotel, with the talking points all around macro-economic influences on real estate regulation, lending appetite and the changing debt markets.
“The interbank lending market is almost not there,” Andreas Wuermeling, head of secondary markets at Deutsche Pfandbriefbank told delegates, “and if it is there it is only for a short period of time. As a result, banks are scared about lending long term money, supported by short term money.”
The uncertainty is polarising lending intensions to real estate, with banks understandably worried that they may lend at the wrong time, and that things might improve by the turn of the year.
As a result of this uncertainty, a number of European banks are shifting new lending plans into next year, but funding markets are unlikely to be any better, added Wuermeling. “We decided to keep going, but we wish that more lenders were still active because we need more debt.”
The last property cycle has certainly left senior lenders with differing perspectives on how to interact with junior lenders.
These range from ‘never again’ to ‘only if it is my way’ to a few who believe junior capital can genuinely be a positive contributor to the overall outcome even in the event of distress.
Michael Zerda, a director who manages LaSalle Investment Management’s two mezzanine funds, said: “Mezzanine deal flow has increased because there is more supply on the market, specifically on the secondary asset side. On the refinancing side, we are seeing senior LTV levels drop – it seems like the new normal is setting in at 60%, compared to 65% last year.
“In terms of the overall cost of debt, we don’t think the cost of mezzanine will move out, but we do think overall cost across the capital structure will as mezzanine becomes a larger component due to lower senior debt LTV levels. And as non-bank lenders come into the senior lending market, this will increase liquidity, but at a price.”
There are a number of pension funds that are expressing interest in providing senior debt, or investing into senior debt funds but at a greater margin than those currently quoted by active lenders, added Zerda.
In terms of regulation, all the talk was of the impact Basel 3, for the banking market, and Solvency 2, for the insurance sector, will have on lending intensions.
“Credit prudence is really going to dominate lenders’ approach for the next couple of years,” argued Paul Rivlin, co-founder of real estate debt investor Palatium.
He added: “There is a tension between two processes going on side by side but are actually at odds: Basel 2, Solvency 2 and, to some extent, Basel 3 all depend upon institutions making their own assessments of what their risks are. On the other hand we have major parts of Basel 3, the Vickers process in the UK and similar processes in Switzerland and for EU banks, which go back to prescribed asset value weightings which simply require higher capital and reserve requirements and extra prudency.”
Not only could banks see their capacity to lend diminish again, but also their will to do so. Capital weighting will not stop institutions from investing in alternative assets like real estate if they think they are going to get teen and higher internal rates of return, Rivlin said.
“There is a lot of expensive work being done on Solvency 2 and Basel 3, but actually I suspect at the end of the day that it will be Vickers and the equivalents that will bite on what institutions can do after the world normalises and in the meantime non-regulatory constraints, particularly internal credit policies will rule the roost.”
The extent to which insurers emerge as the saviours of the great wall of refinancing is another known unknown.
As the British Property Federation’s director of policy Peter Cosmetatos put it: “The challenge, I suspect, is that insurers will want to lend against the type of real estate assets which we don’t difficult to raise debt finance: prime property with strong underlying tenants, as opposed to secondary and tertiary shopping centres.”
jwallace@costar.co.uk