EUROPE COMMENTARY UK banks need private equity

Ernst & Young’s Dean Hodcroft says it is hard to argue that the real estate sector can ‘live’ without the private equity and opportunity funds. PERE Magazine December 2009- January 2010 issue

Maybe it is the potential adverse public relations associated with private equity, or perhaps a combination of factors, but the current probability is that private equity may not get an invitation to the party.

Banks are keenly aware of their new capital structures which introduce a new layer of politics and management on top of traditional business-based decision making processes. With six months until a UK election, the paranoia is evident and the last thing the government needs is the perception (regardless of reality) that taxpayer assets are being sold cheaply to private equity.

Rumours abound from private equity being blocked out of JV arrangements outright, to lists of preferred counter-parties. All of this begs the obvious question: are the banks sure that this is a good thing to do?

The real estate problems the banks have are enormous. Just Lloyds and RBS alone amount to loans in excess of £180 billion. Let’s assume a well structured JV arrangement between a bank and a UK REIT, consists, broadly, of the following features: the establishment of a JV vehicle between bank and REIT; equity from the JV partner into the JV; transfer of assets by the bank into a JV at an agreed price to avoid further write-downs; a loan from the bank to the JV to fund the acquisition; a JV profit sharing arrangement.

Assume now that an asset (more likely a bundle of assets) worth £1 billion at par (loans or foreclosed assets) is already marked down by the bank to £800,000. The bank transfers the asset to the JV at £800,000 and there is £200,000 of value up for grabs.

With debt funding from the bank at, say, 60 percent, this, still leaves £320,000 of equity needed just to fund the JV’s purchase price. Multiply this £1 billion deal by £180 billion, and it seems churlish to add an extra layer of complexity to the overwhelming scale of the challenge. Let’s not forget loan portfolios are not good income for UK REITs. Foreclosures would, presumably, be necessary adding further time and costs just to get to the starting blocks of a JV.

Short of some window dressing and private equity funds sitting behind JV partners as financiers, it is impossible to see how the banks and their preferred JV partners can pull this off, unless the institutions can step in and perform the financing role.

This would be a huge step for institutions and one that seems very far-fetched. It seems unlikely that the case can comfortably be made for the real estate sector to live without the private equity and opportunity funds.