Real Estate Debt - Online Roundtables

Targa Communications

Real Estate Debt - Online Roundtables

Roundtable on Debt Finance

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REFIRE and Targa Communications continued in September with the monthly Roundtable discussions on various subjects, broadcast as live webinars moderated by Charles Kingston of REFIRE and Andrew Barber of Targa Communications. This time the focus was on Real Estate Debt.

Andreas Kalusche, CEO at Prime Capital AG in Frankfurt, opened the Roundtable discussion with a short impact statement. He concluded by saying:

From a demand perspective of what institutional investors can look at, commercial real estate debt is at the top end of what is available in capital markets.

The panellists in the subsequent discussion were: Hanno Kowalski, Managing Director of Berlin-based FAP Invest; Guido Gerstner, managing director of real estate private debt at Prime Capital; Stephan Langkawel, head of institutional clients at Engel & Völkers Capital; and Matthias Sandfort, Group Head of Debt Finance at Corestate Capital in Frankfurt.

Here are some of the key takeaways from the lively discussion, with active participation from an audience tuning in from 17 different countries:

Hanno Kowalski, Managing Director of Berlin-based FAP Invest, which provides access to real estate investments and debt financing for real estate and development projects across Germany, said that the rise of the debt funding sector was due to there being a lack of real alternatives. Fixed income products aren't delivering returns. Institutional investors have upped their allocations to real estate in the hunt for real returns.

There are strong arguments for going into real estate debt over equity - greater flexibility, currently higher returns, and the freedom from having to forecast the long-term trends in real estate.

Bridge loans can last from a year or even less, to no more than 3-4 years, whereas an equity investment means embracing a big trend of 10 years to as long as 15-20 years, or even longer. With whole loans starting at 3.5-4.0%, and mezzanine providing cash on cash returns of 6% and higher, it's understandable that institutional investors are keen to look at this steady, secure stream of income as an alternative to the fixed income products that they invested in in the past, and where they see many of those tickets running out.

Market development


Guido Gerstner, managing director of real estate private debt at Prime Capital, said he saw the rise of the debt funds as essentially unstoppable now. Senior banks will of course still be issuing senior loans, but several current trends in the market make it undesirable for them to lend against hotels or retail.

From a mortgage lending perspective, the gap between the market values and the mortgage lending values is getting bigger and bigger. This can be a problem if you have a certain level of equity at hand and you'd like to go for a 75% loan on the purchase price, but your senior bank can offer you only a 60% loan. This widening of the gap is one of the structural reasons why alternative lenders have been finding this a stable and sustainable business model.

Another is that banks are restricted by their equity commitments which have to be the underlying on their balance sheets. And again, the alternative lenders are more flexible, speedier in decision-making, and with flatter hierarchies leading to much less bureaucracy.

Competition and debt brokers


Stephan Langkawel, head of institutional clients at Engel & Völkers Capital, said his company was able to avoid direct competition with other lenders because he focused on deal sizes of about €8m to €15m per mezzanine tranche. On the question of competing with the big UK and American funds that are looking to muscle in on the European market, he said it wasn't so easy to gain access to the deals without a strong local presence.

On the question of using debt advisors to broker deals, Langkawel said that he like most others often used them, as much of his business was with the German Mittelstand, and they viewed their dealings with developers as very much a partnership - and hence would deliver financing from another provider from among their 300 or so financial partners.

Sandfort of Corestate Capital both agreed that from a borrower's perspective, it made sense to approach debt brokers, to get the job done and to cover your financing needs. They both have direct lending capacities, but a debt broker may be additionally useful because of his network and some specific expertise as to how a deal can be done.

European and Anglo-American approaches


Matthias Sandfort, Group Head of Debt Finance at Corestate Capital in Frankfurt, talked about the difference in pricing between the US and the European market. They are not directly comparable, given different safety profiles, different collaterals and different legal process to get your hands on the assets if necessary.

Kowalski of FAP Invest said he was doing mainly deal sizes in the €30m to €50m bracket for his FAP fund, sometimes bundled into a club deal. There's a lot of business at smaller levels as well, which can be inefficient to handle if it's below €10-15m. This is just too small for the UK and US players, who talk of deals €50m and upwards. But the number of those big deals each year, of €100-€150m mezzanine, is limited.

Favoured asset classes


On the funding of hotel investments, the panelists agreed that hospitality was right out of favour at the moment, although a number of projects are emerging where a hotel is being converted to office or residential space, and even these will attract debt finance - but perhaps not from the biggest institutional names. However, hotel assets in good locations and with good concepts as to their future use should still find lenders willing to support them, even if it takes a couple of years for the traditional lenders to return.

But the panelists also said that what they saw emerging is a need for a certain risk profile rather than for a very particular asset class. Investors are increasingly prepared to take a certain share of the subordinated lending on a project, where the senior lending could be 50% or below, and the lenders can construct the risk return on the mezzanine ticket - making it slightly more independent from the actual underlying asset.

Major risks


On the question of the major risks that the panellists saw facing them in their business, Kowalski pointed out that each deal was highly individual and could not be risk-assessed purely on its industry or asset class. The market in mezzanine is not efficient - you cannot always answer the question of what the fair price is at this risk level. The market is not so transparent that risk can be priced in this way.

Gerstner of Prime Capital said the biggest risk for him was to have a write-off in his portfolio. This can only be addressed by building up an experienced team that have learnt a lot from cases in the past, and by having a solid relationship with your sponsor. If you have to rely on the small print in your contract, it's probably already too late to save the situation.

Langkawel of Engel & Völkers Capital said that as a subordinate lender he always has to anticipate future trouble ahead with the borrower. A fundamental tension exists between the senior and the subordinate lender. The subordinate lender always wants to keep the troubled borrower in business, and will accomodate almost any wish, whereas the bank or senior lender may be pressing to close the business down, and recoup what they can.

Pain points in relationships with bankers


The panellists were agreed that having stable relationships with senior banks was critical, and a solid understanding of their inter-creditor relationships. The pain points were inevitably standstill periods, and agreeing on a price level if you have to buy out on the senior lender.

Gerstner recommended never touching your inter-creditor agreement again once you have it in place - just use the same version again in the future. Kowalski agreed, and pointed to the necessity for speed in the industry and how you may be uncompetitive if you don't have pre-agreed inter-credit agreements, already in place with your major partners even before you do the deal. Sandfort saw one of the main pain points being the level of experience on the banking side, which could hold up the granting of change of control consents and cure rights and cure periods.