Politics and change creating opportunity: CREFC Europe Spring Conference reviewed

By Paul Norman James Buckley - Friday, May 19, 2017 9:00

The CREFC Europe Spring Conference in London once again provided a fascinating insight into developing trends in real estate markets and in particular how they are affecting commercial property finance. Key topics this year included: the increased impact geopolitical events are having on real estate; the best areas for finding yield late on in a cycle and in a lower transactional environment; the difficulty in pricing assets in a world of shorter leases and an increasingly dominant online market for shoppers; increased appetite for alternative fixed income sectors; and the impact that rapidly changing advances in technology and data provision are having on property cycles and how lenders operate. CoStar News reviews the emerging thoughts of leading figures at the conference.

The trade association for European real estate finance market's Spring Conference took place on 10 and 11 May at K&L Gates’s London headquarters with CoStar among a number of sponsors from the finance and property sectors.

There was a notable focus this year on broad trends developing across real estate, as lenders grapple with the issues of valuing assets in a fast changing landscape. There was a particular interest in the increased popularity of shorter lease terms and flexibility in offices, the growing importance of online shopping and how that impacts retail and logistics, and the impact that improving technology and data are having on often opaque markets.

Mark Leonard, co-founder and director of the European Council on Foreign Relations, as guest speaker kicked off proceedings with a panoramic overview of the complex dynamics at play across the European political landscape.

Speaking in the week after Emmanuel Macron had been voted French President, Leonard was clear that Macron’s success enabled a pause for breath for property markets but suggested the upcoming German Election would likely have more impact on economic and political developments across the Continent, not least in regards to the Brexit negotiations. Leonard said: “It is too easy to breathe a sigh of relief and think less about politics.”

Andrew Petersen – K&L Gates finance partner than introduced the conference by highlighting a crucial developing theme as “the emerging importance of real estate as a service instead of a financial asset. In addition, regardless of the cycle more and more people follow the borrower; the funder follows a strong sponsor rather than say I am going to invest in this country”.

Real estate trends

A first panel entitled All change please: trends in train for real estate focused on the changes having most impact on mainstream commercial real estate activity.

Andrew Smith, strategy director, LondonMetric, said: “In terms of longer-term trends, over the past 10 years there has been a huge change in technology. Has real estate kept up? – no. Airbnb is the biggest operator of holiday space but it does not own hotels, uber is the largest taxi company in the world and does not own cars. The operating platform is increasingly important. The important question is how does this add to value overall? British Land research recently found that 89% of all sales touch a store. However recent results suggest that 80% of all sales touch a website.

“In retail the continuing story is that sales via online is growing. Mall owners are considering how to drive footfall. Should they provide a commitment to grow footfall for their retailers?!

“There is much more need for the landlord to focus on the B to C relationship, in how the real estate responds to the end consumer. In offices it is about building the employee relationships.”

Smith disputed the idea that turnover rents would be universally embraced by retailers.

“In terms of turnover rents there is going to be a polarisation in their popularity. H&M is taking turnover leases where they want to in poorer locations and where they see value upside in doing so but will resist in prime spots where the turnover is strong and increasing. There will be polarisation in how occupiers want to use turnover rents.”

Smith also said that for property companies NAV is less and less relevant.

“It is now about creating income streams. Rather than playing the buy cheap sell high game, a REIT should be more about growing revenue on a progressive basis over time."

In addition Smith suggested that traditional expectations around property cycles may need to be amended.

“Property cycles will be shallower. Stronger data, risk aversion and lower debt levels means the near term cycle will be shallower than previous cycles with people adopting a much more cautious and safer approach than in the lead up to the crisis. We believe less will be traded over the next five years too. As a company we will look to strong covenants and longer leases and trying to create certainty.”

Focusing on these issues Tasos Vezyridis, group research manager, Land Securities, said: “In the offices sector occupiers increasingly need smart buildings that are sustainable and that offer a base to support technology. More flexibility from leases is also required and in the future this might affect how we value buildings.

“There has been a big change in the way we lease our buildings with coworking and operators such as WeWork increasingly dominant. There is always a risk that the success of this sector is a feature of the cycle but still it is clear we are moving in that direction.

“In terms of cycles, markets change minute by minute but perhaps the duration of cycles will become shorter.”

Vicky Skinner, finance director, Urbanest, agreed that in the student sector the end user was more and more important in landlord thinking: “We are seeing ever more discerning residents.”

Moderator Gregor Bamert, head of real estate finance, Aviva Investors, responded to a question about what these changes meant for debt funds as they appraise lending opportunities: “In terms of the certainty that debt funds require in this environment, particularly if they would like to securitise then it will continue to depend on the expected sustainability of the particular sectors. It is easier to anticipate trends in the student market for instance. In addition there may be a focus on multitenanted property to ensure a broader perspective rather than single income streams.”

What are the trends for capital allocation?

The next panel focused on the subject of How durable are the current capital flows into real estate and what are the trends in allocation?

Moderator Richard Dakin, managing director, CBRE Capital Advisors, began by pointing to the findings of a recent global investor sentiment survey of approximately 2,000 global real estate investors in which a number of themes had emerged: “Themes emerging include: a strong rise in income related investment; the availability of assets is increasingly difficult; there is a big trend into alternatives; we are late in the cycle; investment volumes will be more modest; increasing focus on value-add; investment wise it is Asian outbound and US inbound.”

Jon Rickert, investment director, GAM, said that he was seeing a range of trends while speaking to investors: “While capital raising we are finding broadly that European investors are afraid of the UK but okay with their own markets. US investors are much more interested in there UK as there is a broad view that values will soften and it is seen as a good opportunity.

“We feel we can find opportunities in the UK that are attractive on a risk adjusted return. We feel values will be off in the next two years in the UK but we are spending more time out of the UK in Benelux, Ireland and Spain where better assets are coming out of private equity portfolios. France and Germany are the most functioning markets in terms of their banks in Europe which makes it more difficult for others to be involved.”

Elsewhere a view was expressed that real estate debt on a risk reward basis continues to be attractive compared to real estate equities and government bonds but it remains very difficult to access real estate debt particularly for new entrants given the infrastructure needed to participate. There are many opportunities but the barriers to entry remain very high.

Paul Jayasingha, Willis Towers Watson, global head of real assets, pointed to the imbalance at present between maturing pension fund liabilities and opportunities to invest in index-linked gilts as a key driver of asset allocation: “There is approximately €2trn of UK pension fund liabilities which are maturing and there are not enough index-linked gilts today to satisfy that de-risking. So, pension funds have to look at these alternative areas, where investors are paid to take the illiquidity risk.”

Borrowers versus lenders

Lorna Brown, the former managing director in the real estate group at Blackstone, moderated a panel entitled Borrowers and Lenders – Going Forward Through a Changing Market which once again pitched senior lenders against borrowers to debate keys issues facing both.

Kicking off with a question to audience members, who had the opportunity to respond via voting buttons, Brown asked: “What is most important to borrowers today?” An overwhelming 80.2% of audience members indicated that pricing and covenants was the priority, followed by reliable banking relationships at 12.1%.

Lars Kreutzmann, Senior Vice-President at Partners Group, who was representing borrowers, disagreed with the audience. “Pricing does matter and covenants but it is far more important to have a lender which trusts your business model. That is crucial.”

Morgan Garfield, managing director at Ellandi, echoed these sentiments. “Pricing is fairly insignificant to us, within reason. It is actually the banks who understand our business plan and are willing to put in an investment of time that is really valuable.”

“Relationships matter”, added Lesley Chen Davison, Portfolio & Corporate Finance Executive at Delancey. “The difference now is, as a borrower, you can’t be beholden to one or two lender relationships anymore, just like you want your property portfolio to be diversified.”

Davison added that she was always more willing to pay a premium to single underwrite a development loan.

“Development is a very frustrating thing. If you have a big project, it is not uncommon to have a club of three, four or five banks and one complicated development loan. The flexibility to manage your asset is so important. What I never hear a lender say is ‘I would give you that flexibility but I would have to charge an extra 50bps for it’.”

“I’d pay an extra 50bps to avoid covenants altogether,” Garfield added.

Responding, Shawn Kaufman, TH Real Estate’s director of debt strategies, said: “There shouldn’t be any risk profile that is impossible to price. Pricing is important but when you buy a car you don’t necessarily go for the cheapest one on the market.

“The agility of lenders to act quickly is certainly something you’d pay a few basis points extra for. On paper there are a lot more lenders now, which is great for market diversity. The senior market is undoubtedly the most competitive, although we don’t like to play in that market as the return is not as attractive.”

The point was then made that in the US many of the transactions do not have performance covenants and this could be accomplished by way of higher pricing, lower advance rate or through scheduled amortisation.

Garfield said he was seeing an increase in refinancings in the market. “The refi market is strong. Appetite from lenders to refi is good and there will be a lot of refis over the next few years.”

Elsewhere it was suggested that the asset classes that lenders are avoiding at the moment are construction and healthcare.

Kreutzmann added: “We don’t shy away from development risk but we do avoid healthcare and hotels in this current market.”

John Bigley, Principal at DRC Capital, said: “It is important to draw the distinction between yield compression cash-outs or adding value through asset management.”

However, Davison contended that there was often a reluctance from lenders to do cash-out refis with development loans. “If, as the sponsor you’ve taken the risk of acquiring and clearing the site, won planning permission and secured tenants, then I don’t see anything wrong with taking some of the cash off the table.

“The more opportunistic your development is, the more commercial you want your lender to be.”

Asked how much control she wanted lenders to have, Davison said: “I used to want to insist that lenders hold at least 35% to ensure the sensible lender was committed and involved. I can’t do that anymore. I have a blacklist of lenders I don’t want to deal with but with all the alternative lenders out there, my list would have to be 100-lenders strong to be considered a reliable list.”

Posing the second question of the session to audience members, Brown asked: “Within the lending community, what do you think that the predominant mind set is?” Once again the response was overwhelming with 57.1% agreeing that the answer was “finding a way to grow income without changing the risk profile”.

Finally, asking the audience what they’d like to see most in the debt market, a less overwhelming response had 34.3% saying they’d like to see less regulatory controls and covenants. A further 22.5% wanted to see more spec development financing and 20.6% called for increased availability of longer term debt.

Long-term values measured 

The conference included a brief update, led by Charles Cardozo of Radley & Associates, on the progress made so far on one of the recommendations from the 2014 report, A Vision for Real Estate Finance in the UK – the recommendation for the use of long-term value measures for lender risk management.

A working group led by Rupert Clarke of Lipton Rogers Developments has tested three different methodologies against historical property market data to see how reliably each is able to anticipate an impending market crash, using only information available at that time.

Peter Cosmetatos, chief executive officer of CREF Europe, said:  "A mean reversion approach based on a historical long-term capital values trend line (Adjusted Market Value) has performed best at the All Property level, spotting every major fall in UK CRE values for which data are available. Further work is planned, principally to improve the performance of the two other approaches –DCF model-based Investment Value, and Mortgage Lending Value, which is based on the approach used by German banks using the Pfandbrief covered bond market. A report is expected to be published within the next few weeks."

pnorman@costar.co.uk jbuckley@costar.co.uk

Get in Touch
+44 203 205 4600