Real Estate Finance 2007
The European real estate market continues to boom, and the capital markets are busy fuelling the frenzy. From financing private equity-backed M&A through lending to feed hungry CMBS conduits, bankers are working hard to fund the growth of property companies and meet the demand from investors for new product.
As an important feature of the current environment, real estate investment trusts (REITs) – the tax exempt vehicles that started life in the US in the 1960s – continue their relentless spread across the world. The latest progress has been in Europe, where countries such as France, Germany and the UK have come to the REIT structure relatively late in the day, but where there is also the prospect of a huge sector developing.
Another source of demand is the expansion of private equity funds into the property sector. This has become a worldwide phenomenon thanks to factors such as growing competition in traditional buyouts and the rising values in many real estate markets. There are concerns that the weight of money could affect future returns, but funds with a hands-on approach to adding value remain confident that they can perform.
However, there are clouds on the horizon. The recent turmoil in the US sub-prime market has put the less developed European sub-prime business in the spotlight. Lehman Brothers, and to a lesser extent Merrill Lynch, stole a march on other investment banks by originating their own non-conforming European RMBS product. Morgan Stanley, Deutsche Bank and JPMorgan have now followed them, but at a time when the sector has lost some of its lustre and investors see more the risks than the rewards, have they made the right move?
There is also the suggestion of greater caution among loan bankers. Highly liquid conditions across Europe and the Middle East mean that the real estate sector has become more attractive to lenders, and yields have fallen as a result. But with interest rates on the rise and those US sub-prime woes putting nerves on edge, perhaps caution should become the watchword for lenders.
And in the structured finance sector, the interplay between covered bonds and RMBS looks set to become more complex, as the risk weighting applied by various bank investor institutions stands to vary considerably under the Basel II regime. It seems that post-Basel II it will be less easy to make money, but much easier to make mistakes.
This report also looks at some of the newer developments in real estate finance. Emerging markets are one potential source of continuing growth, and Russia’s mortgage market is attracting the biggest banks around, despite being worth a mere 2% of that country's GDP. The country’s first securitisation only came in July 2006, but it was rapidly followed by two more, and already market insiders are predicting five or six transactions this year.
Another area tipped for major growth is property derivatives, where the last quarter may have been the UK commercial property derivatives market’s most active yet. On some estimates £2bn–£2.5bn was traded, compared with a cumulative notional of £4.6bn traded in 2006. But it will be the installation of global, over-the-counter commercial property derivatives markets that will test whether the commercial property derivatives markets will flourish in the long term.
Finally, we take a look at the European CRE CDO market. The first deal only came at the end of 2006, but a lot of banks are keen to establish a foothold in the sector.