Emerging Trends in Real Estate® Europe 2012 - PwC

ExHIBIT 2-5
Debt Underwriting in 2012
Standards Will Become
More Rigorous 85%
Source: Emerging Trends in Real Estate Europe 2012 survey.
Standards Will Become
Less Rigorous 1%
Standards Will Remain
the Same 13%
Europe, and international lenders are retreating to their home
markets. One Spanish interviewee described the approach of
the banks in Spain as “financial strangulation.”
But the problems are widespread, and lending will be
curtailed throughout Europe. Many interviewees in Central
and Eastern Europe (CEE) were particularly nervous about
the availability of debt, citing the concern that German and
Austrian lenders, who had been very active in the market,
were curtailing their activity. One borrower commented:
“Everything we heard four years ago is coming to pass.
Austrian banks have been told to stop lending to CEE. Last
year’s good news seems a long way away. The crisis is back
with a vengeance.”
Many interviewees commented on the likely behaviour
of German lenders. The announcement in November that
Eurohypo had been told by its parent, Commerzbank, to cease
lending had come as a shock to some interviewees whilst
others felt that this situation had been foreseen for some time.
Either way, that and other decisions taken by the German
banks were widely seen as highly significant because they had
been such active lenders across Europe. A typical comment
from an interviewee was, “Banks that can raise money on the
Pfandbrief market are still active, but not like they were before.”
The view among interviewees, including the lenders themselves,
was that they would be retrenching heavily and what
new lending they did would concentrate on core assets
in Germany.
This situation was a concern not only to borrowers elsewhere,
but also to some German lenders themselves who saw
a risk of banks all wanting to lend on the same narrow band
of assets. As an interviewee from one German bank noted,
“Most of our competitors are closing down their international
business or at least downsizing and refocusing on the German
market, so we expect stronger competition in our core German
segment.” This is a positive development if you are an equity
investor looking to buy core German assets with low levels of
gearing but is less good news for everyone else.
Debt is going to be not only in short supply but also
expensive. The financing cost for banks has risen significantly,
even without the capital cost of meeting regulatory capital
requirements. The dramatically increased cost to the banks
is being passed on to borrowers, resulting in what one inter-
Chapter 2: Real Estate Capital Markets
viewee described as “eye-watering margins” over base rates.
Interviews with borrowers and lenders alike suggested that
these costs are unlikely to decrease in the short term.
Deleveraging. As already discussed, banks are subject
to very significant regulatory pressure to reduce their assets
to meet capital requirements, and the view is widespread that
commercial real estate lending will be disproportionately hit
by this asset reduction. Whilst some interviewees believe it
will release a torrent of opportunity, others are more sceptical.
The banks face a dilemma. As one lender said, “We cannot
just dump assets because it would create a self-perpetuating
downward spiral. The numbers are enormous.” This sense
of caution is reflected in other interviews with bankers. One
interviewee from a bank in the midst of an active deleveraging
programme commented as follows: “My view is that you have
to be cautious because although we will have short-term dark
spaces over the next six months, things will recover. There is
sufficient activity that will keep the market moving. I would be
cautious about next year, but I think we still have the ability to
sell throughout the year.” As one investment banker summed
it up, “The trickle will increase in pace, but there will be no
tsunami.”
The banks are only part of the lending pool that needs to
deleverage. The issuance of commercial mortgage-backed
securities (CMBS) peaked in Europe in 2005, 2006, and early
2007, the top of the boom market. Although CMBS were never
as dominant a part of the market as in the United States, these
peak-of-the-market CMBS issuances are now moving towards
maturity. It is also worth remembering what went into CMBS
conduits at the time. As the 2007 Emerging Trends in Real
Estate Europe report noted, 2006 issuance was marked by
a more mixed bag of property finding its way into the CMBS
pool, with one 2007 interviewee commenting, “I think there’s
a lot of mispriced paper floating about.” Much of this 2006
CMBS debt is due to reach maturity in the next three years.
As one lender observed, “The CMBS maturities will start to
trickle out next year, but the fortunate thing is that the bondholders
will take a hit on that, not the banks.” Interviewees
closest to the epicentre tended to be more sceptical that the
unwinding of CMBS positions would result in a flood of assets
onto the market. As one commented: “I think that many of the
CMBS issues will also be worked through. Although it is a lot
more complicated than bank lending, many are being worked
through and bonds extended. We are bondholders in a number.
Although some may fail, it will be a minority.”
Several interviewees identified an issue that has been
restricting and may continue to restrict the banks from taking
action: the impact of break costs for interest-rate swaps. The
fall in variable-rate interest rates has left swaps into fixed rates
out of the money. The prognosis of low interest rates for the
foreseeable future means that little prospect exists of this
reversing, leaving borrowers facing significant break costs.
This has been accentuated by borrowers’ widespread prac-
Emerging Trends in Real Estate ® Europe 2012
19