COMMENT: Private equity real estate firms should not bank on the Italian broken credit opportunity

Italy might be the last major source of property NPLs in Europe, but the country does not deserve to be a primary target for opportunistic capital just yet.

For those private equity real estate businesses with an appetite to locate, acquire and extract value from broken credit, it appears that today all roads are leading to Rome. That was one of the major takeaways from the real estate capital markets session at this week’s Urban Land Institute (ULI) conference in London on Tuesday.

Delegates heard from a panel of sector heavy-hitters comprising Goldman Sachs, Blackstone, Lone Star and Eastdil Secured how the NPL market was today approximately 75 percent worked out in the UK and Ireland and 50 percent in Spain. Italy, on the other hand, was just getting started.

According to Cushman & Wakefield’s corporate finance team, Spanish loans accounted for half of the €3.7 billion of closed sales recorded in 2016 so far, with 1,855 sales. Second highest was €1.1 billion in Italy with 1,155 sales.

Subsequently, having jousted for market share in the UK, Ireland and Spain, the aforementioned quartet on-stage (Eastdil on the advisory side) are bringing their tourney to Italy with the purpose of catching as much of the country’s €60 billion to €200 billion – depending on whose numbers you believe – distressed property debt opportunity as possible.

Precisely what level of investment is possible will depend largely on how cooperative the Italian banks are willing to be. ULI’s panellists were right to be assembling a strategy for buying Italian NPLs, but given the potential obstacles to investment, they were right also to demonstrate how they were not placing a disproportionate number of eggs in that particular basket.

Unlike Spain or Ireland, Italy’s economy never collapsed following the global financial crisis – it just suffered. As such, property prices did not fall to a point where clear value for opportunistic investors could quickly be ascertained. As a consequence, Italian lenders, which, unlike their Spanish or Irish counterparts, were not centrally-recapitalized and were not pressured to accept rigid asset markdowns and/or transfer them into a centralized bad bank. As another consequence, major write-downs never happened, just a slow bleed in valuations. Today, underlying asset pricing is creeping into interesting territory for opportunistic capital, but is not unquestionably attractive just yet.

Add to that back story a legal system which remains more accommodating to the borrower than the lender, and an asset base including a great deal of property in secondary or tertiary locations, or which was the collateral of an operating business and not held as investment property, and the challenge for buyers compounds. These factors are off-putting for many investment managers.

Nevertheless, there is increasing pressure from both the Italian government and wider European regulators to see Italy’s toxic loan base shift stewardship. While there still is no bad bank in the form of Ireland’s NAMA or Spain’s SAREB, in that the state will not be using public funds to directly buy bad loans at enforceable marked-down prices, a function has been agreed whereby the state staples guarantees to bundles of NPLs that are sold. From something of a standstill, Italian loan books are beginning to emerge. Cushman’s latest live transactions table has a significant handful of low-to mid-hundred million euro books currently testing the water.

Whether these early offerings trade and the market grows remains to be seen. As such, private equity real estate’s last bastion of NPL opportunity in Europe should not be its primary strategy, but one of a number of ways to capture that much-coveted 20 percent IRR and 2x equity multiple.