EUROZONE: Lenders of first resort

Watching the horror story of Ireland’s bailout unfolding last month reminded investors that a whole chunk of property lending has long since vanished from the European commercial property markets. Indeed, Allied Irish Bank and Bank of Ireland, which previously were powerful lending forces in Ireland, the UK and mainland Europe, lend no more.

With a whole debt supply chain missing and fears of further bailouts of weaker countries to come, it is all the more amazing to hear that, in the US, there is talk of a property lending bubble emerging. In fact, in November, Starwood Capital Group’s Barry Sternlicht and Colony Capital’s Richard Saltzman raised concern over the wave of liquidity looking for a home in core real estate, saying the industry faced repeating the mistakes of 2007 and 2008 all over again. Given the juxtaposition, one has to wonder whether Europe is just behind or different.

If anything, there is feeling in Europe that many traditional lending banks have simply continued to be selective in their lending. That message came through during a recent roundtable discussion that PERE hosted in Frankfurt, when Barclays Capital’s director Ralf Kind said exactly that.

Furthermore, Kind noted that new rules, including incoming Basel III regulations requiring stronger capital adequacy levels, would not help the lending situation for banks. In addition, he doesn’t see the commercial mortgage-backed securities market coming back in Europe anytime soon, the way it has started to do in the US.

If you are an opportunity fund, this is a pretty big problem, and solutions are not that easy to find.

Around the world, there have been recent suggestions that non-traditional lenders will step in to help plug the gap. This point was underlined recently by the law firm of Paul Hastings, which interviewed more than 125 capital providers in Europe, the US and Asia. It concluded that non-bank capital providers, particularly private equity firms (84 percent) and sovereign wealth funds (45 percent), would become increasingly active competitors over the next 12 months. Of course, that was referring to general lending, not specifically to real estate.

Examining the numbers further, however, is less encouraging. Many respondents (76 percent) believed China, Korea and Japan would witness an increase in lending activity, and a considerable majority (68 percent) predicted the same for the US. However, respondents’ outlook for Europe was lukewarm: just 44 percent expected to see increased lending activity in the region. So in conclusion, Europe is in danger of being the odd one out in the world, with no chance of a bubble in sight.

In European real estate, there simply are not that many alternative sources to fill the void. Pramerica Real Estate Investors and Duet Group are active junior debt providers, and there are some newer players, such as the financial services firm Matrix Group in the UK. Still, there aren’t that many players operating with large sums of money at their fingertips.

When it comes to large deals – say €1 billion – there is an even more glaring problem. Traditional banks are loosening up slightly, but they still are only writing cheques of around €100 million. If an investor is trying to buy a large portfolio of loans from a bank – that is, buy debt on the secondary market like Lone Star Funds does – vendor finance is very difficult to come by.

No wonder opportunity funds are working hard to scout out financing from non-traditional sources such as insurers, which tend to originate longer-term debt so that the income matches their liabilities. The UK insurer Aviva is one such firm that is keen to do more.

Meanwhile, AXA Real Estate, which set up a lending business in 2005 and then took a break, is now stepping up to the plate by investing in loans with five-, six- or seven-year maturities. In July, it backed banks that financed The Carlyle Group’s £671 million (€803 million; $1.02 billion) purchase of a distressed London property portfolio. At the time, AXA told PERE that it sees traditional lenders restricted by legacy issues and with no capacity to deal with the wave of refinancings coming due.

Isabelle Scemama, head of commercial real estate loans and corporate finance at AXA Real Estate, said:  “I am convinced we will see insurance companies representing a significant part of the market, like they already do in the US.” But she agrees it is fairly clear that insurance companies (combined with other alternative lending sources) will not be the whole answer, just part of a solution to plugging some of the real estate financing gap.

For now, fears that US players have about a potential credit bubble forming around core real estate seems just the kind of problem opportunity funds would welcome in Europe.