Friday Letter Once bitten

A conversation with a German private equity real estate fund manager at the EXPO Real conference in Munich this week threw the spotlight on a deep-rooted reluctance by German lenders to allow large, discounted loan book sales to US private equity houses like in the mid-naughties. 

It's a strange state of affairs when you hear a German complaining that his compatriots are not behaving more like Americans. Yet, in the company of PERE at the EXPO Real conference in Munich this week, one head of a Germany-focused private equity real estate firm did precisely that.

Central to that manager’s complaint was a stubbornness among Germany's major real estate lenders to sell loans at discounts that would result in opportunistic returns for businesses like his, even if it would be relatively economically advantageous for them to do so. He noted that Germany's lenders hadn't forgotten how US private equity capital consumed billions of dollars in troubled real estate loans for a fraction of their face value, thereby creating fortunes for themselves, back in the mid-naughties.

Exemplifying with deals like Dallas-based Lone Star Funds' September 2004 capture of troubled real estate loans with a face value of $4.8 billion from Hypo Real Estate Group, the fund manager said: “No German bank would ever do that again. They don't want buyers to make another fortune. They won't stand for that.”

Yet, as the Euro crisis continues to deepen, sentiment in the German real estate market darkens. A King Sturge survey released at the event this week reported a dip in sentiment across all asset classes, as its 1,000 participants expressed a sober view of future growth prospects. More importantly, German lenders, which currently account for €255 billion in commercial real estate debt (according to an August report by Trepp, the New York-based provider of CMBS and commercial real estate information) would rather sell their loans piece by piece over seven to eight years than allow what they would regard as a Resolution Trust Corporation-style mass disposition.

Despite little current evidence to suggest German property would become more valuable during that timeframe, a ‘social resistance’ to US capital means such groups would find it hard even getting a seat at the table. Not so in the US, the fund manager said somewhat enviously, pointing to some of the well-publicised sales that recently have taken place stateside where certain banks have recognised a need to salvage capital today rather than drag out a painful process that risks salvaging even less.

When asked whether structured disposals like that of Royal Bank of Scotland's ongoing sale of Project Isobel – a £1.4 billion loan book expected to be sold shortly to a joint venture led by The Blackstone Group – could work in Germany, his answer was less than encouraging. “Even that would be difficult for them. The problem is they underestimate just why these guys can make 15 percent-plus from their investments,” he said, underlining that private equity’s experience in turnaround situations, regardless of the spoils of their exploits, often help their partners as well.

The frustrations imparted at the world' second largest property jamboree (1,600 exhibitors over 64,000 square metres provides some idea of its scale) are nothing new to PERE's ears. During our Germany roundtable, published in this month's issue, participants painted a picture of concern that against a backdrop of dissipating economic indicators – in domestic consumption, construction and energy production to name a few – there was little evidence of banks injecting any urgency into dealing with their increasingly distressed loan books.

As one participant commented, the banks seem to hold the key – and in some cases, they stand between these real estate professionals and the type of deals they are trying to achieve.

At the roundtable, reference was made to an example of one group of German banks offloading to Colony Capital a package of nonperforming loans with a face value of €370 million made to a single borrower against developments in Berlin and Frankfurt. There also was a belief there existed hidden distress that must come to light and be dealt with shortly, but such mention was at that point anecdotal only.

If the words of the German fund manager at EXPO are to be believed, Germany's lending institutions are not shifting enough from their books. An emotion-led desire to ensure that the control of German real estate doesn't end in the hands of US private equity is at least partly to blame, even if such a outcome might do them some good.