Friday Letter Cash is king

The credit crunch is causing a real headache for real estate investors in the US and across Europe. But a return to a situation similar to the early 1990’s means those with cash will rule.  

The headlines this week were dismal news for real estate investors looking for credit. As the credit crunch continues, real estate investors are saying they’re finding it harder and harder to borrow against property assets as lenders burned by the subprime crisis flee the sector. According to reports, typical maximum loan-to-value ceilings have dropped from more than 80 percent two months ago to about 70 percent today. Similarly, reports say banks’ debt margins may have risen by 30 to 40 basis points in that same time.

Reuters yesterday highlighted the positive side to all this for private equity firms, likening the situation today to the conditions of the early 1990’s when a lack of credit gave birth to big private equity real estate players such as Blackstone, Apollo and Warburg Pincus. According to this theory, many of the smaller private equity real estate funds today see themselves as a potential “white knight” during the current troubles, able to offer their own cash for funding at a time when property companies are unable to find credit elsewhere.

Two managers at Brockton Capital told Reuters that their plan is to support property companies by buying shares, providing debt and equity bridges and helping investors to refinance portfolios by striking joint ventures. Then, when liquidity returns to the debt market, the plan is to go to more traditional debt refinancing.

Despite Brockton’s optimism, a lack of credit is obviously a bad thing for private equity. PERE has learned of several potential transactions that have fallen through in the past few months because of the credit crunch, including two potentially large transactions in Finland. Last month, Lehman Brothers was forced to withdraw its €1.5 billion commercial mortgage-backed security issue secured against the Coeur Defense building in Paris, which it bought for €2.1 billion in March. And PERE has learned that managers of at least two UK-focused funds have shelved plans to begin fundraising until a clearer picture emerges of market sentiment.

This week fund manager Curzon Global Partners warned that if the liquidity squeeze forces highly leveraged borrowers in Europe to abruptly curtail their investment programs, real estate investment across the continent will likely slow for the rest of the year. And in this sort of climate, analysts are warning that if funds follow a plan of offering cash now with a view to getting more debt later, they run the risk of not being able to generate satisfactory returns for their investors.

However if the liquidity squeeze is a short one, it could just have the effect of taking the froth off the market and separating the men from the boys. After all, the availability of cheap debt and cap rate compression has artificially inflated returns over the past two years. If balance sheet lenders are providing credit, it follows that only the established managers with long track records are needed to finance deals. It’s still possible that private equity real estate players who have just completed fundraisings could ride this crisis all the way to the bank.