Real Estate Finance: investors play the waiting game

Investment and lending volumes fell in CEE real estate markets this year, but money is available to finance deals and certain asset classes offer attracting investment opportunities today, participants heard at a panel session at the Real Estate Finance Virtual Summit by DD Talks on 9 November, which was moderated by Roger A. Allen, group CEO at RLA Global.

  Investment volumes down

"Over the last 7-9 years we all felt a little bit like Superman-like nothing can really happen to us. Then coronavirus came around all of a sudden and all participants have learned how shaky markets can be in a such a situation," said Martin Erbe, head of international real estate finance for continental Europe at Helaba Landesbank Hesse Thuringia in Germany.

Erbe, who manages Central Europe operations at Helaba, said real estate investment volumes decreased dramatically this year, falling by more than 50% in some markets, with lending volumes declining at a similar pace. But bigger countries, such as Poland, were not as much impacted, as participants fled back into markets with higher liquidity.

Bids for properties have also declined, partially as a result of Covid-19 effects on current rental incomes and the not-so-rosy expectations about future incomes from rental, according to Filip Vucagic, partner and director at Colliers in Croatia. But he added yields were not affected as sharply, at least for prime properties, which continue to be in-demand.

Money is widely available

Allen of RLA Global highlighted that some of the largest private investors recently assembled huge real estate debt funds - Blackstone has raised $8 billion, Starwood Capital nearly $6 billion or Chain Capital £500 million -, which haven't been really deployed yet. Erbe and Knittel said these big players haven't entered the CEE region so far, probably because of the limited liquidity and overall size of local markets. Money is also available from other sources in the region as governments and central banks have introduced fiscal and monetary measures to support and stimulate the economy, Vucagic said.      

Jeff Coe, general partner and co-founder at Limestone Capital, agreed that "there is a lot money in the market", and investors need to find opportunities to put this capital to work. But he said players may find current markets "confusing". Operators and owners are making "terrible money", but they are not pressured to sell because they can tap relatively inexpensive debt to finance their operations.

As a result, Coe doesn't see many transactions happening at the moment. "I'm looking at the same hotels and assets than I looked at a year ago, there is not much new really, and the pricing of these assets isn't really exciting", he said, adding that investors are "sitting on the fence", asking where the great deals are. "Everyone is projecting the deals will come, but nobody knows when exactly, so we'll have to wait and see. It is a very, very weird market," he said.

Covid-19 impacts do vary 

Some deals, however, are still getting done and financed. Dieter Knittel, head of international real estate finance for CEE at PBB Deutsche Pfandbriefbank, said transactions are mostly going ahead in the logistics and office sector, and some retail asset classes - such as neighbourhood, convenience and food-anchored units as well as discounters - are also attractive. Average deal values range between €60-70 million to €200-300 million though CEE, he said.

Panelists said that Covid-19 has hit certain asset classes more than others and current valuations may influence investor sentiment differently in each market segment. Logistics is seen as the most attractive market at the moment, while expected discount rates are fairly moderate in the office and residential segments, at 10-20% and 5%, respectively. Retail and hospitality have discount rates in the region of 30%, with hotels being the hardest hit at the moment by the current pandemic.   

Hotels not ready to sell, yet 

In Croatia, a popular leisure destination in Europe, the hotel sector is overwhelmingly financed by commercial banks, which in many cases gave a moratorium on loan repayments to market players, Vucagic at Colliers said. As a result of this, hotel owners are not ready to sell as they are "more comfortable" and hope to keep going in the current situation until business returns to usual after Covid-19, maybe in one to three years.

Hotels "are kicking the can down the road, hoping that this all will go away, and business will be back by, for example, the middle of next year when they have to pay their first instalment and interest," Coe at Limestone Capital added. He also said hotels with no large cash supply or access to relatively cheap debt from governments or commercial banks in more stressed European markets may have to take private debt - which may put them under bigger pressure and may result in selling the property in case they can't finance this more expensive debt.

Force majeure clauses could increase in importance in hotel management agreements, which may be possibly reshaped due to the currently unfavourable market environment, participants in the webinar heard. Coe said operators still need to be ultimately responsible for owning the risks, although enforcing this can be "tricky".

Erbe at Helaba added that showing a panic reaction and going into foreclosure is not a solution at the moment. "If you want to foreclose a hotel in these times, will there be any buyers? At what price will there be any buyers? This would make sense neither for the banks, nor for the investors," he said. He suggested the right solution may be speaking with the borrower and trying to find a reasonable solution on the property in question.

More creativity in financing

The panelists said debt financing is more prevalent in CEE at the moment than equity financing, which in part is also due to the strong role of banks across the region. But Coe said financing methods are expected to become more creative, with lenders also becoming equity owners and some owners, for example, only selling a part of their projects. "We are in a very new space and we are not sure where we're going, so the most obvious reaction from most investors is risk-mitigation," Coe said.

Knittel at PBB Deutsche Pfandbriefbank added that participants are working to stabilise the market and try to avoid fire sales by making efforts to find alternative solutions, such as waiving amortisation or discussing government structures. He also said the CEE real estate market is functioning, transactions are still happening, and some investors are active.

Where are the gold nuggets?

While it is still uncertain when markets will be able to return to normal after Covid-19 and many investors are taking a wait-and-see position, speakers said they were hoping recovery may happen sooner than later. Knittel said he is optimistic about 2021 and sees the current market environment suitable for investment - either for entering a portfolio or acquiring a trophy building - due to increased liquidity and government support. "As an investor, I would buy now," he said.    

Vucagic also expressed optimism about investment opportunities in CEE real estate. He believes it is a good time to invest, with logistics and industrial real estate being appealing as the importance of e-commerce is increasing and production is coming closer to Europe from the far east, primarily from China. Shopping centers are something to be avoided in retail, while hotels may be interesting, if there is an opportunity to acquire with a discount, he added.

In terms of specific opportunities in the hotel sector, Coe said the "gold nuggets" have to be within repositioning properties, as hotel guests are looking for different experiences now, mostly around wellness and wellbeing. He said investors may be able to pick up bigger assets that are positioned incorrectly, and change them into a more attractive properties. "That's where you're going to see double-digit IRRs," he argued.

The new "what if" scenario   

In a new development that took place after the DD Talk virtual summit, pharma firms Pfizer and BioNTech announced that preliminary analysis indicated their Covid-19 vaccine was more than 90% effective. Global stock markets skyrocketed on the news, with some airline and cruise company stocks jumping by 20-30%, while "stay-at-home" stocks, like Zoom or Netflix, fell. 

The announcement also points to a possible new scenario about recovery in real estate markets. What if an effective vaccine comes out earlier than most participants currently expect? How would that affect real estate investors sitting on a huge pile of capital, still waiting for the right opportunities to buy?  "This ’what if’ scenario shows that the wait-and-see strategy of many investors bear significant risks – which includes being left with piles of uninvested cash that was not deployed and missing out on potentially lucrative earlier deals," Allen at RLA Global said.  

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