HOT MARKETS: Mediterranean moves

After a prolonged dry spell in the wake of the global financial crisis, Europe has come back onto the real estate investment scene with a vengeance. In fact, the turnaround in the Continent’s fortunes is so complete that two markets in southern Europe, once thought of as far too risky, recently have emerged as hot destinations to park capital, particularly for real estate debt investors.
The Spanish and Italian markets often are lumped together as examples of the burgeoning distressed opportunity in Europe, with sales of nonperforming loans (NPLs) serving as the primary enticement. A list of the active investors in the markets reads like a who’s who of the private equity real estate world, including The Blackstone Group, Cerberus Capital Management, Lone Star Funds and Kohlberg Kravis Roberts, among others.
“Over the last 12 months, the big shift we’ve started to see is that, not only are there more opportunities in continental Europe, but more opportunities in southern Europe,” says Ken Caplan, senior managing director and head of real estate in Europe at Blackstone.  The New York-based firm notably has been one of the most active buyers in Italy, but it made big news in Spain over the summer when it purchased Catalunya Banc’s €6.4 billion Project Hercules portfolio of bad residential loans.
While these two markets have been heating up and drawing international attention, the results of the European Central Bank (ECB)’s asset quality review and stress test of European banks could impact the current flow of capital. The results, which will be published this month, could initiate an increase in deal flow in southern Europe, or they could open up more stable markets and draw investors away from Spain and Italy.
Relieving the pain in Spain 
In the timeline of southern Europe’s economic recovery, Spain emerged as a viable investment option earlier than its Mediterranean neighbor. In November 2012, the nation set up its bad bank, Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria (Sareb), and quickly became an active seller in the market. As of July, Spain boasted 
€192 billion in gross non-core real estate exposure, and Sareb held more than 53 percent of this exposure at a value of 
€102 billion, according to a report from Cushman & Wakefield.
HIG Capital’s credit affiliate, Bayside Capital, was the premiere buyer in Sareb’s sales, acquiring the first property portfolio sold by the bad bank – a €100 million transaction comprised of 1,000 homes in August 2013. Bayside managing director Ahmed Hamdani notes that the firm recently has focused on buying single assets in Spain, including shopping centers and hotels. Its current strategy does not involve vying for large portfolios, which attract a lot of competition from big players. 
“We’re targeting a slightly different universe of NPLs,” says Hamdani. “We’re focused on the smaller portfolios from smaller banks that we can source directly, and that’s really the key challenge to investing in these countries: finding the right opportunity.”
The tactic is necessary in such a bustling location as Spain, where investors are drawn to the distressed secured loan portfolios coming to the market, along with the massive oversupply of residential product. “Just about every serious distressed debt investor, or at least those focused on real estate, is now focused on the Spanish market,” notes David Edmonds, global head of portfolio lead advisory services at Deloitte. 
Blackstone has done big NPL deals like Project Hercules, but it also has been working with local operating partner Magic Real Estate to build up its multifamily portfolio. Meanwhile, the firm has been growing its logistics portfolio with the purchase of six Spanish logistics assets from Gran Europa in August, reportedly for €130 million. 
As private equity firms continue to compete for assets in order to deploy large sums from their billion dollar-plus funds, all the activity on Spanish soil might not be a good sign, Edmonds notes. “I would argue that it’s become a bit of an overheated market because of the sheer size on the demand side,” he says. “Still, we are seeing a lot of deals coming through and that’s set to continue for at least the next two to three years.”
Hamdani agrees that competition is heating up, but he notes that there is still plenty of product to go around. “If you have the local presence, the local resources and you’re ready to put in the time to create your opportunities, there’s a lot to do,” he says. “It just requires investors to run harder and be a little more creative.”
Entering Italy 
From a macroeconomic perspective, Italy is a “different kettle of fish,” notes Edmonds. While the nation has its own issues in the commercial real estate sector, it has not experienced the same kind of significant real estate bubble as Spain. Bigger Italian banks have started to raise significant provisions in the last six months, but smaller and mid-tier banks have yet to do so. As a result, the country has been slower to emerge as a potential market for private equity real estate capital. 
“In the Italian market, we’ll see a trickle of deals over the next nine to 12 months,” says Edmonds. “There are a few deals going on now, but they’re relatively small. It will become a more active market as we get into the end of 2015 and early 2016.”
Blackstone is a major player in those current deals. Caplan notes that the firm saw some opportunities in Spain when it was first looking at both markets, but it preferred Italy because of the sellers, which currently include local private companies, European funds and banks.
“In Italy, we were able to make more inroads with sellers that led to more investible, actionable opportunities,” Caplan says. “That really started building on itself as we were able to develop a reputation with those who wanted to sell with speed and certainty. We were able to buy some really good pieces of real estate at attractive pricing.” 
Some of those pieces include shopping centers like the Franciacorta Outlet Village purchased in September 2013 and offices like the RCS Mediagroup headquarters in Milan, acquired in November 2013. It also bought AXA Immoselect’s portfolio of office and retail assets worth €250 million in April, as well as more industrial investments for its Logicor platform. 
In June, Bayside acquired its first Italian NPL portfolio from banking group Cassa di Risparmio di Ravenna for €40 million. The transaction was structured by Bayside’s servicing partner, Fare NPL, which is an Italian asset management company.  
Hamdani notes that one feature of the Italian market is navigating the often lengthy process of working out NPLs. “The jurisdiction in Italy is problematic – there’s no getting around that – but you need to price that accordingly and make sure you have partners who know their way around the system,” he explains. “There are many ways of recovering NPLs and going through the courts will take a long time, but the system can work more efficiently. A new owner of an NPL portfolio has a little more flexibility to cut deals with borrowers directly, which an existing bank would not have.”
The C&W report also portends of “more to come from Italy following the asset quality reviews” by the ECB.  Even though Italian lenders have a relatively low exposure to non-core real estate in comparison to the UK, Ireland and Spain, the global real estate services firm expects this figure to increase. 
Indeed, the reclassification of loans will lead to a higher level of NPLs held on balance sheets, resulting in the development of clearer exit strategies and further disposals in order to meet capital requirements. C&W notes that UniCredit and Intesa Sanpaolo are in discussions to set up a bad bank, which will have investors “circling Italy, eager to take advantage of any opportunities.”
Establishing a presence 
While players have approached investing in each country differently, they have gone about establishing a presence in Spain and Italy in similar ways. Some investors have been buying loan workout and recovery units from banks that sell them as standalone servicing operations, giving the buyer a 10-year loan serving agreement along with the sale, notes Edmonds. Cerberus was one firm to go this route, buying out Caja Madrid in 2010.
“That’s a major feature of the market, and six or seven banks have gone through that process,” says Edmonds. “For an investor, it’s about recognizing that the opportunity is coming, putting roots down fairly early and becoming part of the woodwork if you’re going to stand a chance of being a major player in that market in 12 to 18 months’ time.”
Another essential step in becoming “part of the woodwork” is establishing a relationship with a local partner. Blackstone works with strong local operating partners like Magic as well as its own pan-European platforms, such as retail-focused Multi Corporation.
“Historically, there were a lot of longstanding relationships with operating partners and capital sources, and there was a bit of a change post-crisis as those capital sources disappeared or changed,” Caplan explains. “It created an opportunity for us to align with operating partners that might not have been possible pre-crisis, and that’s one of the reasons we’ve been successful and more active in those regions recently.”
Put to the test 
This month, the ECB will publish the results of its comprehensive assessment before it takes on its new role as supervisor of 130 European banks. The quality reviews will put pressure on those banks to reduce the size of their balance sheets and restructure their operations.  This could turn inactive areas into new hot spots and possibly make big sellers out of German and French banks as early as 2015, according to Edmonds. That may mean the Italian and Spanish banks will find it more difficult to attract buyers if investors gravitate to northern Europe’s more stable economies. 
“Italy and Spain have a lot of NPLs and they’re very interesting, but they’re the only game in town at the moment,” says Edmonds. “The minute the sleeping giants wake up, investors will start to move a lot of their interest and money to northern Europe or they’ll stay in Spain and Italy and demand a higher return, which will impact pricing.”
Looking ahead in the region, Blackstone is eager to see what large loan portfolios will come out of the ECB’s stress testing. While the results may open up northern Europe, it likely also will mean an increase in the already vast southern European market, which will help to balance out the current demand.
“There’s definitely a lot more interest in the area,” says Caplan. “However, when you look at the scale of that interest and the actual capital that has been committed versus the scale of the opportunity—the size of some of these portfolios and the amount of deleveraging that still needs to happen—there’s still quite a lot in front of us.”