Five years ago, it was easy to make money in property. Banks were keen to lend, investors optimistic that their grand projects would only ever increase in value. But, when the music stopped, reality dawned and we now live in very different times.
Several banks have required government support, and lenders are sitting as the default owners of major swathes of distressed property. So for those keen on continuing forward in the real estate world, the new landscape is very different. And access to debt finance – traditionally the lifeblood of property development – will, it appears, remain constrained for some time. Faced with this challenge, where are the opportunities and what are the models that will work?
Peter Denton, UK head of real estate at bank BNP Paribas, stresses that the current funding shortfall is not any reflection on the real estate world: rather, it is other, external forces. “The decision making has nothing to do with property.” The issue, he says, is one of banks getting their houses in order following the banking crisis – and all investment classes are experiencing the same pressures.
“We were expecting to have six to seven years to be Basel compliant,” says Denton. Instead, an accelerated timetable means many banks will now achieve this hurdle during 2012 – and that has led to drastic action on their parts, with a knock-on effect on the property sector. “For almost all banks, they have a relatively straightforward choice: reduce the size of their loan books, or raise equity.” With currently depressed share prices, the equity raising option looks the less attractive of the two, and so it is loan book reduction that will continue to impact property funding in the short term. “We tend to take things very personally, but this has nothing to do with property.”
But there are positives Denton can see. “For the first time ever, I can see the creation of a non-bank funding market,” with pension funds and insurance companies entering the field in the search for good, solid-yielding returns. “They still need yield to meet their investment requirements.” Peter Damesick, EMEA chief economist at CBRE, agrees: “There is a widespread expectation that insurance companies will take a bigger share of the property lending market, as has happened in the US, but it will take time to develop.”
“We will see a more complex market,” predicts Denton, with banks acting as go-betweens. “The complexity will arise in who is lending, and what do they need? There is an investor base who, for example, might have bought bonds, who will come into property loans instead. This is likely to be the main way to inject substantial new liquidity into the property lending market.” Banks will act as lenders in their own right but also facilitators and agents for this more passive capital.
If that was the good news, the bad news for the immediate future is that this change may take some time. “The immediate future looks quite challenging,” says Denton. A lack of debt and banks own funding costs are pushing up lending margins/fees. With a substantial volume of loans coming up for refinancing, that could be a challenge. “Only the very best deals will get done, or only the very best priced deals.” And, with plenty of attractively priced loans to provide on secured on standing property, there will be little incentive for lenders to step into the riskier area of financing new development.
For those with equity, the current market presents opportunities. Van Stults, one of the founders of Orion Capital Managers, is busy investing in property on behalf of institutional investors in his company’s funds. Around 40 per cent of his investors are from the US, the balance spread around the world, and at the end of 2009 Orion’s third fund attracted €1.28bn of equity to invest in property across Western Europe.
“If you can find the right asset at the right price, then we will proceed,” says Stults. He has not been afraid of purchasing shopping centres in Spain, investing €235m in buying the Plenilunio Centre in Madrid; and more recently acquiring 50% of the Puerto Venecia shopping and leisure centre in Zaragoza. And in London, where the high end residential market remains very strong, Orion has recently bought two development sites, choosing to build rather than chase completed stock.
“We employ debt on individual deals, to the extent that funds are available. But we’re using substantially more equity than in the past: and it’s going to take even more equity in the future.”
Stults echoes Denton’s view: “Most of the sellers are selling for financial reasons, not related to the property. There are going to be more opportunities – the challenge is going to be pricing them.”
Joint ventures are one clear way to share risk in uncertain times. The central London office market, for example is seeing substantial commitments from foreign investors, replacing bank lending. “Virtually all the schemes in London involve foreign equity partners, notes CBRE’s Damesick. “There is a degree of appetite from the Middle East and Asia”, while Canadian pension funds and Chinese interests are already in play.
And joint ventures are extending to partnerships with landowners, giving them payback later, rather than cash up front. One successful exponent of this is Cathedral Group, a developer now working with several public authorities in the UK to revitalise town centre sites. The public sector is a major landowner, says Cathedral chief executive Richard Upton, “but they’re desperately nervous of joint ventures with developers. The irony is, the business model of private and public working together is recession-resistant.”
Upton’s expanding team is working in town centres including the London suburbs of Clapham and Bromley, building mixed use projects, often close to transport nodes. “We’re bringing forward what the market requires,” says Upton, “as what’s actually needed is the re-creation of inner town centres, a bit of place making.” And with plenty of projects on the go, this new approach is gaining traction. “In simple terms, the land goes into the model, the private sector takes all the risk, but does not have to pay for the site,” explains Upton. “In return, we share the benefits in an open-book way.”
MIPIM 2012 devotes a special set of conferences to investment and funding issues, features Investors Power Meetings and a special Germany-themed Investor Quest.
Image: Dimitry B