Friday Letter Awaiting the Yankee wash

With real estate financing in Europe still difficult to come by, one of America’s biggest commercial real estate lenders is ramping up in the region, pointing the way for its fellow US banks.

The naysayers would ask how on earth US banks could even think of ramping up lending activity for European real estate at a time such as this. After all, each market is in a very different place, with Spain and Ireland at the bottom of the pile and Germany at the top.

Not only that, but with the European bloc supposedly heading for a double-dip recession, how does a US lender build in sufficiently robust economic forecast performance figures, when one doesn’t know where some of the economies are going to be in the next three years? Indeed, if Spain, Italy or another country is in danger of pulling out of the euro, not only does a bank have to price in the macroeconomic risk, but also the potential for devaluation. In certain markets, that makes it almost impossible to underwrite a real estate loan.

There are, of course, many answers to that, which were well argued at this week’s EXPO REAL conference in Munich during a session called ‘Real Estate Finance: What can Europe learn from the US?’

Rob Wilkinson, chief investment officer at AEW Europe, said the volume of capital needed – and the scale of the challenges before Europe – was not to be underestimated. Yet, if a senior loan provider in an established and robust market such as the UK were to lend at a loan-to-value ratio of 45 percent to 50 percent, then that is a very significant buffer. In fact, it is a buffer big enough to take into account devaluation of some of the currencies and indeed lack of economic growth across the region.

As the other panelists pointed out, a separate challenge is who would finance the more junior pieces of an existing real estate asset or portfolio. Jeff Citrin, managing principal of Square Mile Capital Management, said that, in the US, private equity firms, pensions and insurance companies are helping out, and that would come to Europe too.

However, the third answer is perhaps the most interesting, and it comes from Wells Fargo, the largest lender to commercial real estate in the States.

Charles Fedalen, executive vice president at Wells Fargo’s real estate banking group, suggested that returns on bank loans made in the US simply won’t look as attractive as they did before. As third quarter earnings results are likely to show, “the word on the street is that the net interest margins for all the major banks will be compressed,” he said.

In other words, the difference between what a bank makes on loans and what it pays to use the funds itself is narrowing. Apparently, that margin is tightening by between 100 basis points and 125 basis points.

Given that margins are shrinking, there is a clear incentive for banks to look to other markets outside the US in order to improve performance. Fedalen said there is no reason to suppose that commercial real estate lending in the US will suddenly reverse course. However, with the market becoming increasingly more liquid and, consequently, competitive, there is a solid reason to expand elsewhere.

Wells Fargo already is doing this. It began a big lending push in the UK a few months ago, and Fedalen suggested that one can expect a wash of other US lenders in Europe to follow suit. Such an influx of financing would be most welcome, particularly in light of the dearth of activity by Europe’s traditional real estate lenders.