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Lending markets in second-tier cities bloom

Published on April 19th, 2017

Large banks lending in Europe’s cities have undoubtedly become more cautious over the last 12-18 months as they keep one eye on the potential for further political surprises after Brexit and the other on how far real estate markets are through the cycle, writes FinanceWatch editor Jane Roberts.

Along with reducing leverage a touch, and preferring to back the most experienced sponsors, these banks are focusing more and more on big deals in the most liquid markets – which means the capitals and gateway locations coveted by global capital rather than second-tier cities.

But it doesn’t necessarily follow that investors targeting second-tier city investments are strapped for debt. They may need to pay a little more, but there are other sources willing to lend, or which are fashioning whole businesses around transactions largely avoided by all but a handful of domestic banks. And with investment yields correspondingly higher for more ‘off-piste’ stock, slightly more expensive debt is still accretive, even at margins of 300-450 basis points.

“A lot of senior lending isn’t the hot property it once was for banks” states Stuart Hoare, the former Citi banker heading up a new lending business at pan-European adviser and asset manager CR. CR has built up a track record since 2008 advising on debt workout and now sees an opportunity to raise capital to lend.

“There isn’t the huge number of banks trying to push the product that there was before the financial crisis”, he continues. “So alternative lenders have come in and have been successful in parts of the market, for example in mid-market senior lending.”

It’s a gap where CR and others see an opportunity. “We’re looking to concentrate on small loans in European countries where there is an opportunity, such as Holland, Spain and Portugal for example,” Hoare explains.

Investors in second-tier cities in the Netherlands particularly stand to benefit from this trend. A handful of debt funds have been lending here for a while, including DRC Capital which was one of the first pan-European debt fund lenders, providing mezzanine originally but in the last two years also lending senior and whole loans.

More are coming in, and like CR and DRC are looking for higher returns than the lower margins from lending on the keenly-priced, prime Amsterdam/Ranstad area transactions or  on big residential portfolios which the Dutch and German banks and insurance companies like.

As well as the gap left by banks, newcomers see lending opportunities increasing due the pick up in investment transaction volumes as secondary Dutch property markets continue their gradual recovery: €13.5bn was invested in Dutch real estate in 2016, an absolute record and more than in 2007 according to CBRE. More capital is going to secondary assets and second-tier Dutch cities, as EMEA head of research Jos Tromp observed when CBRE published its 2016 figures: “We see investors broaden their horizon caused by a scarcity of prime product. In their search for yield they look beyond Amsterdam at cities such as Rotterdam and Utrecht. We also see increasing appetite for alternatives.”
There is a third attraction in the Benelux region now: refinancing borrowers who have assets secured by loans in recently traded non-performing loan portfolios. “The opportunity is fuelled by NPL trades like Lone Star and JPMorgan’s acquisition of SNL’s Propertize for €895m; (private bank) Van Lanschot’s Project Lucas sale to Cerberus (which had a principal balance of €400m); and FMS’s €585m (face value) Project Hieronymus sale to Goldman Sachs”, says Robert-Jan Peters, director of debt and structured finance at CBRE who covers Benelux. And there are more NPL sales to come, with banks like Rabobank still to unload a lot more non-core assets.

This trend is a motivation for GreenOak which invested its first debt fund in 18 UK transactions, but last year took the decision to target Europe too with its latest capital raise. The private equity firm is believed to have some £1bn of new equity for investing in debt with about half said to be allocated to continental Europe.

Jim Blakemore, partner and GreenOak’s head of debt, says: “We are lending in Northern Europe, so Ireland, the Netherlands, Germany and the Nordics, places where it’s increasingly difficult for borrowers to get finance on certain deals.

“In Ireland and the Netherlands we are seeing the distressed cycle playing out and these countries are behind the UK. Buyers like Lone Star and Cerberus are not long-term holders of the assets.”

While active domestic banks like ING and ABN Amro may refinance for existing clients what Blakemore calls “the easier” loans or properties coming out of these large trading portfolios, there will be plenty of borrowers needing debt from other quarters to refinance less mainstream assets via discounted payoffs (DPOs).

Of Greenoak’s first three loans closed in the Netherlands in the last six months, two funded DPOs for borrowers, one from Rabobank and the other from Lone Star. GreenOak lent €28.5m to Office Value Fund in November to support the refinancing of six office assets comprising 46,000 sq m, managed by Profound Asset Management, located in Utrecht, the Hague, Rotterdam, Almere, Leeuwarden and ‘s-Hertogenbosch. The DPO was completed via the new GreenOak loan and asset sales. Blakemore’s team also provided a €34.2m loan to Dutch fund manager Annexum in a similar transaction.

And there are more businesses, with deep knowledge of the Benelux property markets, which are moving into lending as well. As Europroperty revealed in January, US private equity firm Garrison aims to repeat a successful run lending in Ireland, this time in second-tier locations in the Netherlands. Garrison has teamed up with Dutch-based Virgata, set up by Jordi Goetstouwers Odena who used to lead Lone Star’s Benelux activities. They will lend against more secondary, regional assets where banks are either very conservative or aren’t lending at all. Virgata will lend mezzanine or whole loans at higher LTVs than banks. Goetstouwers Odena told Europroperty: “We can afford to be be picky. There have been several billion euros of loans sold in loan portfolios.”

Meanwhile, M7, the pan-European fund manager, is advising a new company called Tunstall which is raising an initial €150m to provide loans of €2m-€10m. Headed by Richard Croft, M7 has transacted over €1bn of equity deals in the Netherlands.

CBRE’s Peters says the cost of debt for Benelux borrowers ranges from as low as 150 basis points for the very best assets in second-tier cities to coupons of 6-7% for severely-distressed assets in challenging locations. An example of the former is the €350m acquisition last year of De Rotterdam, the 160,000 sq m office and hotel complex in the city by Amundi and L’Etoile for Korean investors Korean Federation of Community Credit Cooperatives and Meritz Securities. Pbb Deutsche Pfandbriefbank subsequently financed the asset at 155bps over Euribor at a 55% LTV.

“Debt for mixed office portfolios, needing some re-letting costs in the low 200s bps,” Peters says. “And there is a 20-30 bps premium generally for financing retail. Secondary office properties, that need fixing but are in a good local market, start moving towards 300 bps at lower leverage of 50-55%. For more severely distressed DPOs it’s from 400 bps. The coupon at higher leverage, 70% LTV for example, might be 6%-7%, but would be compensated for by yields which would be around the 10% mark for these assets.”

Spain – Return of the domestic banks
Spain’s debt market is functioning well again with more competition to lend and pricing correspondingly lower than it was two to three years ago.
But, much like the Benelux region, the players are less homogenous than before and  international banks and large institutional lenders such as Allianz and AXA mainly want to back global investors buying the very best logistics or regional shopping malls, or offices and business hotels in Madrid or Barcelona. Development remains very difficult to finance outside these cities.

In second-tier cities, the better bet for borrowers are the domestic banks, which have been increasing investment lending on property. “Pre-crisis we didn’t see Spanish banks in commercial real estate so much; their focus was more on residential development” says Manuel Gil who is head of real estate finance for pbb Deutsche Pfandbriefbank in Spain. Pbb wants to increase its lending in the Spanish market; recently, the bank participated in a €70m loan to TH Real Estate and Neinver secured on Nassica Retail Park in Madrid that was arranged by Deutsche Asset Management.

Now, Spanish banks including Caixa and Santander and increasingly others like BBVA, Popular and Sabadell are lending on commercial real estate. For larger deals they are clubbing together, although mainly for relationship clients.

Across the market, Gil says, “over the last few years margins have been driven down but pricing has stabilised now and so have loan-to-values, at a still healthy level.”

France – Lyon is star second-tier city
Among European second-tier cities, Lyon is one of the most popular, according to respondents to the most recent Urban Land Institute/PwC Emerging Trends Europe report, published last October. Out of 30 ranked by investors for their prospects in 2017, the French city was 10th, ahead of capitals such as Amsterdam, Milan, Warsaw, London (at the time, suffering heavily from the Brexit effect) and even France’s own capital, Paris.
As a consequence, debt liquidity is good, with all the main French banks and the German pfandbriefbanks lending. “Debt is not an issue at all when you invest in Lyon..as long as you have a good property, you will not have to pay a higher margin or take a lower loan-to-value than in Paris”, as one respondent put it. This is with a yield premium of about 100bps over the French capital.

“It’s a fantastic city, like a little Munich”, says Philippe Duvergne, managing director and head of real estate finance in France for Munich-headquartered pbb Deutsche Pfandbriefbank. “However, due to the generally smaller size of the assets, there is a slightly different investor base there compared to Paris.”

The city does have its share of international investors. Pbb has financed transactions for ADIA which has built up a significant holding of the prime retail in the city’s 2nd arrondissement. The sovereign wealth fund bought some 30 Haussmann-style buildings in rue de la République and the Grolée block in the same street in 2013-2014. In 2015 it is thought to have added to its holdings with the 11,000 sq m Rue de la Re Printemps store plus associated offices and residential, from ANF Immobilier.

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