Distressed German Real Estate Debt
14 December 2011
Respondents in almost three-quarters of the 25 countries surveyed in the report expecting rising levels of foreclosure over the coming quarter. Significantly, property professionals responding to the survey expect that supply will outstrip demand in 60% of the countries covered by the survey, a sharp 20% increase compared to the second quarter of this year. Within Europe, however, Germany remains fairly stable despite the shaky economic environment across the continent as a whole.
REFIRE sat down this week with Ralph Winter, the chairman of German real estate investor Corestate Capital and Professor Dr. Nico Rottke, the head of the Real Estate Management Institute (REMI) at the European Business School in Wiesbaden. Corestate and EBS-REMI have just established a new joint research centre for Distressed Real Estate Debt.
“The purpose of the research centre is to analyse the steep rise in real estate debt within a scientific framework and to lay down a basis for improving transparency to deal with the biggest financial crisis since the second world war”, says Winter.
Worldwide, distressed assets valued at €1.4 trillion are currently being marketed, while an additional €1.2 trillion of commercial real estate loans are due to mature over the next four years. Of these, about €500bn are in Europe, while €125bn of these loans are in Germany. “Debt finance is either no longer being provided by banks at all, or only for investments with very low risk. This situation is only going to get worse and will lead to a steep rise in the number of distressed real estate portfolios.
The banks are no longer able to meet the public need for adequate credit given the new minimum capital requirements now being imposed upon them. Financing of real estate investments as we know it is a thing of the past, and nobody can now predict what ex act effects this is going to have on the market – a situation which we can fairly describe as the “New Normal”, said Winter.
Dr. Rottke, who’s heading the academic research side of the new initiative, said the goal was to better determine the relationships on the market between the relevant physical assets and the underlying loans, but also to create added value by taking on the role of ‘honest broker’, with the research centre acting as a central repository for reliable and up-to-date bank data – the lack of which so far has helped to keep the waters very muddy for all participants.
Distressed assets in Germany are primarily commercial properties, but residential port folios are also heavily affected, particularly where foreign investors over-estimated the market potential when entering the market en masse some 5-6 years ago.
“Foreign investors firstly paid too much without any particular local market expertise, and then wrongly thought they could manage their property assets without having a presence in the market”, said Winter. “The inevitable result is a multitude of portfolios which can no longer service their loans out of cash flow. We have to find a new approach to provide a new basis for property investment, and also to promote better communication between banks and investors to prevent the degrading of assets from ‘performing’ to ‘non-performing’ and the subsequent destruction of asset values.”
Winter is at pains to point out that the true downturn in the market lies ahead, with the wave of prolongation of loans maturing in 2012 and 2013 acting as the catalyst for the collapse into ‘non-performing’ status.
“The key thing is – these are not necessarily non-performing loans right now, but their financing is due shortly for prolongation. The banks however, will not be able to prolong these loans, because of the type and character of these investments, which no longer meet the banks’ new lending criteria. The margin will have to be higher, the level of equity capital will have to be higher, leading to a coming ‘death spiral’.
“What I call the ‘new normal’ refers to loans that need to be prolonged, or loans that from the investor’s point of view are only distressed in terms of their valuation, but where the lending institution, such as Eurohypo, now refuse to prolong the debt. So, from being a ‘healthy’ as set, it suddenly becomes a ‘distressed’ asset.
“I’m convinced that the German banks will simply not be able to afford these kind of mass write-downs on assets. Rather, it’ll be more like a ‘salami’ approach where slice after slice is written down – of course the first thing to be written down is the investor’s complete equity capital. But the banks are likely to take an approach similar to that in Japan and take a little bit of pain over a long extended period of time.”
Meanwhile, REFIRE sat in on a panel discussion on “Distressed Debt” at the recent PERE Forum in Frankfurt’s Villa Kennedy, of which REFIRE was the principal media sponsor. Panellists included a number of old veterans from the last wave of NPL sales in 2003-2004, and included Winter of Corestate Capital (pictured, right) Ruprecht Hellauer of Albulus Advisors (and previously founder and CEO of Lohnbach Advisors) and Alexander Hesse, the head of real estate investments at Lone Star Germany.
Hellauer and Hesse shared Winter’s view that the main driver of the coming default rates will be the upcoming maturities of loans that may currently be still-performing. They too expressed doubt as to whether the German banks – apart maybe from the Landesbanken which are already undergoing major structural change – could actually afford to sell off sub-performing loans. Foreign banks with big German loan books are much more likely to want to clear whole swathes of bad loans off their books – these could amount to €50bn of about €300bn total outstanding German loans, they agreed.
All the panellists were agreed that the emphasis has now shifted from pure valuation, to liquidity and funding, which will inevitably lead to a reduction in lending as German real estate lenders find further access to funding drying up. Banks will certainly become more selective, and lending will become more expensive. But they expressed scepticism that a new wave of NPL selling was imminent – in part because of the lack of financing available for the NPLs themselves, compared to the last wave in 2004 where financing was abundant for NPLs and SPLs.
Hellauer, whose previous company Lohnbach Investment Partners was a voracious buyer of NPLs in 2006/2007, said that this time around pricing is not likely to be so aggressive. The attractions were still there however, he said, because you’re buying the loan at a discount to the real estate value. “And if the real estate market turns against you, the worst thing that can happen is that you work for free, because it eats into your discount before reaching the purchase price”, he said.
Hellauer’s company made attractive re turns on their investments, he added. The key lessons he learned were, firstly, the necessity of having the same people that do the underwriting do the actual workouts, and not two different teams – and secondly, the importance of staying in a niche, such as retail real estate, where you can build a platform which you can service yourself, while combining underwriting with the execution.
Alexander Hesse of Lone Star was a little more circumspect on the profitability of the business. “You CAN make money in the NPL business if that’s your only focus, and if you build up your own dedicated asset management platform. But it’s hard to make money – it’s certainly not a windfall. In the last wave 2003-2006 every major investment bank got into this business, maybe allocating $500m or so to give it a whirl. I’m not aware that any of them made any real money, and I suspect many of them lost quite a lot.”
Ralph Winter also cautioned against unrealistic expectations. “The problem in Germany is that potential NPL buyers are not necessarily on the same page as the banks in terms of how they value their assets. The money that the big guys have been raising over the past 2-3 years is all geared for 20%-plus returns. This is extremely difficult to achieve in this completely changed environment. For one thing we don’t have the volatility that exist in other countries, so it’s really tough to create value out of these assets.”
Charles Kingston, Editor, REFIRE (Volume 5, Issue 91, November 30th, 2011)