Real estate financing descends into turmoil – IFR News

Uncertainty resulting from the “gating” of seven open-ended retail UK property funds threatens to curtail financing for the country’s commercial real estate sector.
Such funds have helped fill a financing gap over the past few years following the collapse of commercial mortgage-backed securitisation after the financial crisis and the retrenchment by UK bank lenders.
Open-ended retail funds now have about £35bn of assets under management, representing around 7% of total investment in the UK CRE market. The seven funds, with £18bn under management, were gated last week in the aftermath of the UK’s vote to leave the European Union, meaning that investors were barred from taking out their money.
“We do anticipate a market slowdown,” said Howard Meaney, managing director of global real estate, UK at UBS Asset Management. “There were double-digits returns for the past three years and that is not sustainable.
“There will be fallout from the referendum result. City office [fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][building] was oversupplied and that pull-back will be magnified by recent events.”
Peter Cosmetatos, chief executive of the lenders’ trade association CREFC Europe, agreed that there was more trouble ahead. “The spate of gatings for open-ended funds … presents a problem. You don’t need a fundamental reason for something to go wrong,” he said.
The Bank of England said in its Financial Stability Report on Tuesday that adjustments in CRE markets driven by leveraged investors or buyers of open-ended funds could lead to a tightening in credit conditions.
The risk of forced selling has been reduced by the decision to gate funds, but the central bank said any amplification of market adjustments could hit economic activity by reducing the ability of companies to use CRE as collateral for financing.
“We do anticipate a market slowdown. There were double-digits returns for the past three years and that is not sustainable”
The loss in confidence could also trigger a pull-back, at least temporarily, by new institutional lenders and non-UK bank lenders.
Foreign cash has accounted for 45% of the investment in the sector since 2009, according to the Bank of England, although foreign inflows fell by almost 50% in the first quarter of 2016.
Insurers and other new entrants supplied 22% of CRE loans in 2015, while international bank lenders provided one-third of CRE debt, according to a report from De Montfort University.
The enormous appetite for yield in recent years from the non-bank sector has been satisfied through debt funds, the syndicated loan market and CRE-origination platforms. CMBS, once a mainstay of CRE funding, has all but dried up.
“Without securitisation, these [lending] markets are now completely private,” said Cosmetatos. “That means there is limited ability to compare structures [and] reduced market transparency. So we are not able to learn lessons.”
Fewer alternatives
It also means there are fewer alternatives for the CRE loan market to fall back on.
Debt due in 2016, according to De Montfort University and Fitch data, amounted to some £27bn on balance sheet and £1.7bn of loans within CMBS structures.
The UK CMBS market has struggled to recover since the financial crisis, undermined by a sharp reduction in the investor base and the availability of cheaper loan funding. The market has been especially moribund this year, with no UK publicly placed deals so far. In 2015, there were just two public CMBS trades – totalling £746m.
Earlier this year, Varde Partners tried to place a CMBS secondary deal backed by £185m in loans, but sources said it was ultimately refinanced privately due to limited appetite from investors.
Last year, the circa £170m Antares 2015-1 deal from RBS was also unable to clear the public market.
“There just isn’t a CMBS market there any more, particularly for secondary and tertiary property,” said Simon Cooke, a founder director of APAM, a specialist UK asset manager with a focus on distressed debt and CMBS.
These fresh jitters could be the final blow for near-term CMBS issuance and present huge challenges for refinancing.
According to JP Morgan research, there are some £6.2bn of outstanding UK CMBS transactions with on average just 1.5 years until maturity.
“Some of those will be looking for refinancing and some will certainly struggle,” said one CMBS investor.
Market sources said Deutsche Bank’s Deco 8 – UK Conduit 2, which is backed by commercial properties formerly owned by Mapeley, is among the trades in need of refinancing before October.
Notes from Eclipse 2006-4 CMBS, backed by a portfolio of properties that includes Goldman Sach’s River Court offices, are also due to be repaid in the autumn.
Morgan Stanley’s Ulysses ELC No. 27 is another deal heading towards maturity – in July 2017 in its case. The underlying loan, of which £429m is outstanding, is backed by the CityPoint tower. Fitch this week downgraded a part of the deal in its first negative CMBS rating action since the Brexit referendum.
“If they can’t get refinancing, then you’re looking at the sponsorship behind it to see if they’re going to step up and provide a bit more equity on the refinancing,” the investor said. “It all goes back to: Can they bridge a gap if there is one?”
Higher standards
In the loan market, lending has already been trending towards tighter standards. Most major UK banks and building societies have been conservative in their lending, real estate players said, and now account for 45.4% of CRE loans, down from 66% in 2008.
In their place have stepped in non-bank lenders and insurance companies, with the latter’s market share climbing from zero to 15.1%, according to the De Montfort study.
And more recently, there has been “increasing caution to the terms being offered”, with tighter covenants and lower LTVs, said Rebekah Tobias, a partner at Cushman and Wakefield, a CRE services firm.
Tobias said there are signs of a two-tier market emerging, where properties with good fundamentals are being financed but trickier assets with high vacancies, part pre-lets, poor locations or weak single-tenant covenants struggling.
“Bank credit committees will be looking very closely at leverage and even pulling lines for anything that is South-East England risk,” said one UK-based banker.
Sell, sell, sell…
Still, there are already signs of asset sales that could begin repricing the market.
Alecta, Sweden’s largest pension fund, earlier this year mandated advisers for the sale of all its international property investments, including its £464m UK commercial real estate book.
Aberdeen, Henderson, Threadneedle, Canada Life, M&G, Standard Life and Aviva Investors – the seven firms that suspended investor access – now also have to sell properties.
They have already haircut the value on their property funds, as did the likes of Kames, L&G, BlackRock and F&C.
“The million dollar question is whether there’s enough liquidity to buy them out without them having to take such a huge hit in value that it impacts the overall market,” Cooke said.
“If the only buyers are vultures, there could be a significant repricing that creates the evidence for a value fall. And then we have a snowballing effect.”
Fortunately, there is only a minimal new property supply overhang, according to analysts at Barclays, with half of under-construction space already pre-let. And little more will be built soon – at least in London – until the UK’s future in Europe is clearer.
“If you haven’t started a City scheme yet, you’d be quite brave to put a spade in the ground until there’s further certainty,” said Meaney at UBS Asset Management.[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

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