FAP Group
The FAP Mezzanine Report 2023
Alternative financiers, despite profiting overall from the reluctance of banks to increase their property lending exposure, are nonetheless feeling the negative effects of high inflation, rising interest rates and the undeniable falling market values of many properties they've underwritten.
This is the clear take-home message of the 9th annual issue of the widely-followed FAP Mezzanine Report, which has just been published.
Hanno Kowalski, managing partner, FAP Invest
Despite growing demand for financing, the appetite for risk is rapidly diminishing. The market is already noting the first defaults on existing mezzanine financing, and nearly all institutional investors have quit lending mezzanine capital directly.
Hanno Kowalski, managing partner at FAP Invest, "The current market phase shows which loan funds have weaknesses in the craftsmanship of subordinated capital. Major differences in quality are now coming to light that no one wanted to admit before. Currently, investments in financings in which the real estate project is not fully financed from the development phase to completion have a problem. The same applies to financings that are not based, at least within the term of the loan, on actual values created and realisable in the event of a sale."
Move from project developments to existing properties
The market is currently seeing a stark move away from project developments and towards existing properties. The days are over when financiers were happy to invest in land while speculating on high returns when the land later got developed. Obtaining financing for any such projects is now only possible with heftily increased equity capital. The focus of investors is now firmly on the debt yield and real cash flow, a figure which in the past was often conveniently ignored.
As a result, mezzanine or whole loan financing is no longer being used for land banking investments. Loans to purchase sites with a loan-to-value (LTV) of 50% have become the absolute exception. Although sites in the Big 7 cities have a slight advantage, as a consequence site values will have to fall significantly or buyers will have to stump up far more equity in future to protect the loan, along with much speedier permit processing and start of construction than Germany has been used to.
Trend towards much smaller ticket sizes, lower LTVs
The FAP Report shows that, while the trend in previous years was clearly towards larger tickets, they are now becoming significantly smaller: only around 6% of the survey participants are still granting financing amounts of more than €100 million - in 2022 there were twice as many. The favoured size range of most alternative financiers is currently between €10m and €50m, while anything less than €5m is not seen as worth the time and effort involved.
While FAP put the average loan-to-value (LTV) for existing properties at just under 85% last year, it slipped to 80.6% this year. For a project to be considered by an alternative financier at all, at least 15% equity capital must be contributed - with the trend towards en even higher amount. This is also reflected in the average loan-to-cost (LTC) of 84.4% (down from 87.5% last year).
Kim Jana Hesse, Head of Capital Partners, FAP Finance
What did borrowers pay for mezzanine finance this year? The FAP Report says the average annual interest rate for mezzanine capital in 2023 has been 12%, with capital most frequently being disbursed at interest rates between 11% and 13% per annum. Annual interest rates range from 8% to 17%. This compares to an average interest rate in 2022 for existing properties of just above 10% per annum, and 11.5% for project developments.
Kim Jana Hesse, Head of Capital Partners at FAP Finance, commented: "Mezzanine is clearly slipping down the capital stack in the current market phase, and a quality is coming into the market that has not existed in this way in recent years from a risk perspective."
Whole loans have become even more attractive, for both lenders and borrowers. With their mix of classic senior and supplementary subordinated financing, they are often in the position that pure senior loans were in just a year ago. Only with whole loans, therefore, can financing maturities still be achieved that were previously represented by the senior alone.
Which asset classes are favoured?
All survey participants indicated that they were following the asset classes "mixed-use" and "residential". While office real estate was still in second place last year, it now slips to third place - even though 94% of respondents said they are still committed to offices. Hotel and leisure properties are showing a strong recovery: 66% of the participants stated that they finance hotel properties - an increase of 20 percentage points compared to the previous year. Leisure properties are financed by 34% of the survey participants, compared to 11% in 2022. In the popular residential asset class, the focus is particularly on A and B cities - within which the preference is definitely for first-class locations.
The actual surveying for FAP's 9th Mezzanine Report took place between February and June 2023. For the first time since the introduction of the Mezzanine Report, the FAP Group said it was unable to measure the volume of mezzanine financing this year, as the number of financings actually carried out was too small, with the volume too small-scale. Large transactions were almost non-existent, and the available free subordinated capital being used in a variety of other ways.
In its assessment of the lending market, the FAP Report also reflects on the role that the current climate of energy transformation and the focus on sustainability characteristics are playing in adding to uncertainty. While capital costs for alternative lenders and banks are converging, the appetite for risk is diminishing and financing ratios are shrinking, affecting both classes of lender alike. It is no surprise that both are increasingly practicing a policy of 'cherry-picking' in deciding where to deploy their resources.
