At GAM Investments’ Weekly Investment Meeting held on 26 June 2019 the speaker was Andrew Gordon, who discussed the opportunities in real estate debt.
Real Estate Debt
The investment case for real estate debt remains unchanged: the combination of re-regulation and deleveraging in the post financial crisis era has caused banks to reduce their presence in the mid-market European commercial real estate (CRE) space. This has created a structural funding shortage, which, in our view, creates opportunities.
This pullback of traditional lenders has come from three interconnected themes. Pre 2008, overexposure came from banks issuing large amounts of long-term debt at high loan to value (LTV) ratios. Pre-2008 competition had led to weak lending standards and over-stretched LTV ratios. Today, banks are more conservative and cautious than ever before. Meanwhile, regulatory change has increased banks’ capital costs and triggered an overhaul of their activities. The Basel III framework imposed higher capital requirements and caused banks to shrink their balance sheets and review their overall approach. The clean-up of loan books was the only option for banks wanting to wind down their CRE lending. Between 2012 and 2014, banks sold EUR 80 billion of CRE loan assets, according to data from CBRE. However the ratio of non-performing loans (NPLs) remains at historically elevated levels. All of this has restricted the market to low levels of leverage by historic standards.
We believe the European CRE market offers better risk-adjusted opportunities in debt than in equity; this broad opportunity set is mainly centred on Ireland, Iberia, Benelux and the UK, based on the fact these markets are more creditor friendly.
Within the UK market, it is also interesting to note the “old order” of sectors has reversed, with industrial property now offering the highest value, driven in part by long-term leases signed by the likes of Amazon. Retail property, meanwhile, has suffered by comparison as high streets and shopping centres have come under pressure, although some opportunities remain. Performance from offices has been stable, with low vacancy and development rates, both of which are positive. However, we believe there are fewer opportunities within central London, on the basis that the City has a tendency to be volatile, while the more defensive West End is expensive and therefore we think there are more opportunities in peripheral areas.
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Source: GAM unless otherwise stated.
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