Where is New Financing coming from?

At the recent REFIRE London Conference, John Lutzius of Green Street Advisors moderated a very lively session examining the direction of new financing for real estate investment in Germany.

Lutzius summarised the story of Gagfah, who only a year ago were staring at a giant refinancing. The market felt certain that Gagfah would have had to make major portfolio sales to bring down debt levels. As it turned out, without having to make disposals, Gagfah refinanced over 4bn of debt at very sharp rates, and has seen its stock up 2.5 times in the period.

Curth Flatow of Flatow Advisory Partners said that the 4th quarter shows a balanced financing market, with over 50% of lenders reporting an increase in new business. Big banks like Aareal, Pfandbriefbank and BerlinHyp have all raised their new business lending by over 40%, with average LTVs at 69% and margins at 185 bps. Getting finance for A- and even B-locations is not too difficult, nor is financing for any core-type assets, with perhaps more difficulty for niche products like hotels and nursing homes.

Flatow was asked, would there be margin compression in 2014? There is certainly more competition to finance core assets in Germany, he responded, so he expects a gradual lowering of margins from currently about 185 basis points next year, apart from in trickier niche segments.

Dr. Matthias Grund of K&L Gates LLP described the market as being in a transition period. We are not experiencing gaps for financing in prime locations, while even in distressed deals, there have emerged several new providers of finance, including family offices and private equity funds. In his practice he still sees a lack of linkage between local expertise and investors sitting in big cities looking to gain exposure to the German market. It’s the in-between deals that are struggling to find financing, he believes.

Jacob Lyons managing director at CR Investment Management, described the issue with the capital stack as a bit like herding cats. You’re trying to get the borrower, the senior lender, the portfolio itself, and potentially a junior lender, all into a room at the same time, which can prove very tricky with the different goals that each are trying to pursue.

As Lyons described it, the hedge fund and private equity fund community is split into two different groups. Big players like Cerberus, Blackstone and other experienced investors are to some extent constrained to looking at very large deals because of their investor expectations. Then there are the American private equity players that may have a discretionary pool of funds that can look at Europe, but for them it often proves too complicated and unfamiliar.

Hence, last year 80% of the largest deleveraging deals were done by Deutsche Bank and Lone Star, he pointed out. Even this year there are still only about eight active players. In short, there are the traditional players, and then a lot of noise, as he put it.

Lyons highlighted two critical features about the German market. Firstly, the Pfandbrief market, which provides for financing around a certain structure, come what may. Secondly, the number of banks. Germany is probably overbanked, he said, but UK is underbanked, with a shortage of addresses to go to. He made the observation that Germany seems to have a number of people to go to on a deal that would normally make sense. In the UK you’re often not sure if for example HSBC or Nationwide are really ‘open for business’ at any particular time. Lloyds, Barclays and others dip in and out, but there is not the same sense of ‘stability of model’ as in Germany, which he sees as a real strenght.

Michael Morgenroth, the CEO of Caerus Debt Investment described his core business as handling mezzanine pieces between 10 and 30 million.

With banks previously lending 85-90% there was never any real need for mezzanine providers in Germany, so this is a new segment in the business here. There is now a dramatic change in the market, which now needs structured finance. The demand for such financing in deals in the smaller B- and C-Cities is really big, said Morgenroth. Cost of financing is on average in the range of 10-12%. His company is acting in the space of 50-80% LTV, depending on the property. He also confirmed that he sees no shortage of senior lending in Germany at very competitive rates.

Morgenroth doesn’t see margins on the mezzanine side contracting too fast. There will be new competitors, but it will take time. If the ECB ends Quantitative Easing, and interest rates rise, then availability of financing will shrink, so he doesn’t see any immediate shrinking of margins.

Jesse Freitag-Akselrod of Akselrod Consulting presented the key findings of his recent study with Peter Barkow showing how the listed space in Germany is not small compared to the openended and closed.end fund sector. Listed companies in Germany own gross asset value of about €68bn, while all the funds together have about €69bn, he reminded the audience. The difference is that the funds are generally measured by gross asset value, whereas the listed companies are traditionally measured by equity market capitalisation, so there has been an unequal comparison.

Free float market cap in Germany is about 25% of that of the UK listed property sector, and about 50% of that of the Netherlands, so there is plenty of upward scope, he believes. He gave as an example Deutsche Annington’s accessing of capital for refinancing their bonds prior to their IPO as a very innovative approach. Understanding the markets in this way, he said, has opened up whole new market for other participants in the benchmarked bonds segment.

Akselrod said he would not be surprised to see increasing volumes in debt capital markets, à la Gagfah, both in residential and commercial. After the recent wave of IPOs and capital issuance and the strong run on the market, he thinks that investors are now much more selective, So he sees little new issues on the horizon.

Commercial property however has still lots of demand, particularly with the impairment of the open-ended funds. But near term, he said he is advising his clients, don’t force your way onto capital markets, get your house in order first. There may be a recapitalisation or a merger here or there, but not like we’ve seen in the residential space, he believes.