Insurance firms with lending capability and North American investors seeking European bank debt are expected to outperform
The upcoming London Olympics will be a festival of sport on a global scale. And the real estate industry is also a global phenomenon: although all real estate is ultimately local, the credit crisis has shown that our finance markets and economies are linked and interdependent, as are the economic forces that they produce.
Over the past decade, the debt and capital markets have helped to transform real estate, an asset class that had been regarded by institutional investors as illiquid and cumbersome, into a global asset class.
So who will be winners and losers of the 2012 real estate games? Will there be a sprint to recovery or will it be the first leg of a marathon that will require endurance, patience, positioning, and strength to complete?
These are the questions to be considered at the upcoming “2012: An Olympic Challenge” conference held by the Commercial Real Estate Finance Council – Europe, held at K&L Gates’ offices on 27 and 28 March.
Mind the gap
Will insurance companies fill the funding gap? Insurers continued to increase their presence in the commercial real estate finance market during 2011, both in terms of the number of players and market share.
The Solvency II directive (still under revision) is likely to make property lending more attractive than direct real estate investment owing to differences in the risk capital requirement. It is therefore expected that more insurers will enter the debt market, and they could well be winners in 2012.
The eurozone crisis
There is further concern over the state of the UK economy and a worry that property values may fall again. This, combined with economic and political instability in the eurozone, upcoming regulations and higher capital adequacy requirements, may mean that lenders remain largely risk-averse through 2012 and beyond, sticking to conservative financing deals on prime real estate in core UK markets. Eurozone countries will pick up the least number of medals.
Deleveraging/portfolio sales
There remains intense pressure on European banks to deleverage as a result of regulatory and economic requirements.
The flow of debt portfolios coming out of European banks has only just started. A number of large loan portfolios will continue to be offered by the banks in 2012 and 2013 and beyond. These portfolios will be the target of North American money, which will be among the winners.
Securitise the Olympic village?
Towards the end of 2011, British asset-backed securities began to regain popularity with certain investors. In 2011, UK banks issued almost £26bn of residential mortgage backed securities. The majority of this was US dollar-denominated to appeal to US investors while avoiding the more unstable areas of the EU.
It looks likely that increases in ABS issues will continue through 2012, with some UK banks announcing new issues. Residential mortgage-backed securities bought by overseas money will be strong medal contenders.
And the gold medal goes to
the Financial Services Authority for slotting! The FSA’s June 2012 proposed rule change will make debt even more scarce and could require UK banks to raise up to £40bn of capital to cover losses from bad property loans. Slotting – a stricter classification of loans and the amount of capital that banks must hold against them – may, if introduced, result in a loan not able to be refinanced on “current market terms” being classified as “weak”.
De Montfort University’s last survey of property lending, in December 2011, showed that £114bn of property loans fall into this category so, on that basis, more than £30bn would need to be raised to fill banks’ capital gap.
Finally, we should remember that 2012 is an election year for at least eight countries from some of the biggest real estate markets, including the US, France, Russia and China. As a result, the political drive to solve these financial problems may slow or even stop for a while.
So there we have it. The establishment of real estate as a global asset class in its own right is unlikely to be reversed, and real estate will re-emerge as a popular asset class.
And now, more than any year since the crisis began, an immense and expanding global pool of funds is searching for this type of investment.
Andrew Petersen is a partner at K&L Gates
