Local banks will remain hesitant to lend against property acquisitions throughout this year given their concerns about the existing quality of their property loan portfolios, concludes a recent survey by the European Banking Authority (EBA).
In the third quarter of 2023, the EBA conducted a thorough survey of banks across Europe. Analysis of data from German financial institutions indicates a nearly 10% increase in the volume of non-performing loans (NPLs), surging from €31.02 billion to €34.02 billion euros between the close of 2022 and September 2023.
Notable is the growth in non-performing commercial real estate loans (CRE loans), at 72%, with the volume rising from €5.7bn to €9.7bn. Banks and their collaborating service providers face significant workload ahead, as realisations and loan sales offer limited opportunities for value optimization. Restructuring concepts, paired with consistent workout strategies, do certainly look more promising.
Jan Düdden, managing partner at Frankfurt-based distressed real estate specialist Arcida Advisors, sees plenty of uncertainty ahead. Persistent sales challenges, stemming from a complex combination of rising construction costs, elevated interest rates, and declining property values, are hindering transactions. And, when refinancing is due, the necessary revaluations of many properties will cause further problems. How financiers handle non-performing loans will lead to a high need for restructuring, against a background of steady insolvencies among project developers, as well as countless construction stops.
Düdden anticipates more devaluations, unavoidable covenant breaches, and an expanding gap in debt finance. Open-ended property funds will come under increasing pressure and cash outflows will continue to rise. As market prices are below valuations, only limited liquidity can be generated through sales. And, while the new regulations for open-ended property funds following the financial crisis have tightened the holding conditions in order to protect the market from mass sales, a run on a fund cannot be excluded, although it hasn't happened yet.
However, Düdden believes that, amidst the challenges, opportunities exist for investors adopting an anti-cyclical approach. Many foreign investors, including those from Asia-Pacific, are scrutinising the German market carefully. looking for partners with local expertise. Several, like Blackstone, have already announced commitments but have yet to kick off their campaign.
Foreign investors looking for 'special situations'
REFIRE recently spoke with Fabio Carrozza and Daniel Endemann of Stuttgart-based BF.real estate finance GmbH about what foreign investors are looking for in Germany at the moment. Endemann joined Carrozza's team eighteen months ago from LBBW to boost BF.real estate finance's drive to extend its reach among international investors.
Endemann confirms that many of his conversations are with investors who are looking for 'special situations', where a really attractive price might spark some action. But at the moment the price of assets, particularly offices, is still not right. "If they'd gone to a 30-times multiple before, now all they want to pay is 15 times." There's no shortage of money, there's plenty of dry powder waiting for the right opportunitiy, he says, with opportunistic vehicles priming themselves for distress situations. In his view, the wider economic issues affecting Germany are NOT disproportionately discouraging investors from committing to Germany, nor are they avoiding the country in favour of others.
"Numerous German investors who heavily invested in real estate are now grappling with the repercussions of widespread repricing", he says. "The risk appetite of German banks is waning and many foreign investors are getting ready to fill the gap." But he concedes that deals haven't been happening as quickly as many had anticipated.
Preferred targets for investors
In terms of asset classes, logistics is still the preferred class, while sale-and-leaseback transactions, along with hotels, grocery stores and student and senior living portfolios are attracting the most interest. Office are still scaring off particularly US investors, who are observing the carnage in their own market.
Potential investors are also sniffing around projects that have recently filed for insolvency by their developers. The BF.real estate finance managers say that with many insolvencies being self-administered, former managers are often reluctant to give details on their current mezzanine lenders or other sensitive information, with the result that price expectations still remain too high.
Parent company BF.direkt is a 50% shareholder in Nova Fides, a new consultancy founded in September last year (along with insolvency experts Annette Benner and Dr. Gordon Geiser, as the company's top management) to help financiers and borrowers whose financing is now deemed 'distressed'. The company certainly expects the number of sub-performing real estate loans to increase, a trend that would in turn generate considerable demand for advisory services.
In reality, there is a scarcity of experts in the German scene with the necessary experience, following a prolonged period during which established players, such as Situs and Hudson Advisers, significantly reduced their operations.
Francesco Fedele, CEO of BF.direkt AG, remarked, 'Today's real estate industry barely has any restructuring experts with the necessary know-how. Many of the classic real estate lenders largely dismantled their restructuring or settlement departments in the wake of the financial crisis."
Nova Fides' Dr. Gordon Geiser commented: “Whenever a loan experiences a default in performance, it is crucial to respond directly and not to delay addressing the issues. An external advisor can often help to expand the room for manoeuvre in the restructuring process, and may possibly prevent insolvency altogether.”
Trimont boss Harris expects more distress
Dean Harris, managing director EMEA for loan servicer Trimont, said earlier on this year that Trimont expects to see an increase in 'distressed' loans over the coming year. Most well-capitalised sponsors with equity in their assets will show support for their investments, he said, through loan prepayments from equity, or targeted asset sales. "But there will be an increasing number of sponsors that are unwilling or unable to support their transactions. There are likely to also be some sectors and geographies where there is simply no lender appetite to restructure or refinance existing loans as they reach loan maturity. This will result in more loan sales, albeit discreet ones, and ‘non-consensual’ property disposals," he said.
He added: It is our opinion that the level of ‘non-consensual’ activity might be more pronounced than the market expects. But we believe that such activity will be phased and gradual during the year, and we do not expect to see the same degree of distress that was evident during the early stages of the global financial crisis. There is also more liquidity in the market, and we believe that equity investors, at home and abroad, will be willing to make strategic investments for targeted assets and sectors.
AXERIS Capital offers entry point to nimble investors
REFIRE also spoke recently to Baar, Switzerland-based AXERIS Capital, an investment manager specialising in the debt segment. Headed by Ricardo Brehme (CEO) and Julian Hartmann (COO), the company is currently arranging several club deals with debt investors. It also has its own debt fund in the form of a Luxembourg SICAV-Raif, which is currently 80% focused on distressed debt, as in non-performing financing.
AXERIS sees lots of opportunities with Anglo-Saxon and Middle Eastern investors who prefer not to invest in a blind pool but rather want to know exactly what they're investing in up front. Brehme and Hartmann see German investors sitting very much on the sidelines at the moment, while foreign investors are aggressively looking to get in on a deal if they can get a steep discount. This could involve teaming up with AXERIS and a few others in a club deal, bundling up a new portfolio from a distressed owner, investing and refurbishing and within a few years creating a new institutional product from what had become a non-institutional portfolio.
To clear the path for subsequent new capital to be introduced, the cash flow on existing assets has to be a good match, as does the pre-letting rate on developments. For offices (not AXERIS' main field, which is residential) the pre-letting rate is not the only factor, but rather - who is the tenant, and how stable are they?
Hartmann reminds us that German banks are much slower than their US or UK counterparts to process bad loans through their default department, and are happy if there is a new buyer, maintaining the safety of their loan. Existing owners of distressed portfolios are watching their situation deteriorate by the month, and are being forced to look at offload options, which is AXERIS's partnership proposition. The company focus is on residential rather than commercial property
Both Brehme and Hartmann believe the strength of AXERIS is that they bring no legacy deals into their company, which was founded less than two years ago. As Brehme says, "Anything that was financed after 2019 is now on the books with a certain value that no longer corresponds to the current market value." Equity and an existing mezzanine tranche often have to be written off in such cases. Hence, as an investment manager with a debt background, a good track record, working cleanly, and - importantly - carrying no defaults into this latest financing phase, Brehme believes that the factor "Timing" has been good to the company. (REFIRE: It certainly sounds like a good argument.)
Who'll be the winners over the coming years?
So, who will be the winners over the next few years? AXERIS's Brehme and Hartmann see further retrenchment by the property financing banks, who'll be too busy dealing with their impaired loans to consider much fresh lending. The opportunities are there for alternative financiers offering mezzanine, whole loans, senior lending or junior mezz debt products.
Hartmann says most of their enquiries are off-market, coming from the borrowers' side, rather than banks, "who rarely act pro-actively". He adds: "However, we would like them to be. So we go to the bank with the borrower and look for a solution together." At the moment, it is mainly regional credit institutions - cooperative banks and savings banks - that have financed projects that are now proving to be in difficulty.
The AXERIS team still view Germany as a stable market, more so than volatile Spain, for example, which has attracted a lot of attention from the distressed bounty-hunters in the past. Germany has been expensive these last 11 years - now is the chance to find underpriced opportunities. By the time the Germans are ready to buy again, the prices will have gone up and the moment will have passed, say Brehme and Hartmann, with a wry smile.
