American Real Estate Investors Seek Opportunities in European Debt Crisis
While the world is anxiously watching to see how the European debt crisis will unfold, many real estate investors in the United States are eagerly seeking opportunities to reap profits from the Continent’s distress.
Private equity firms, whose investors include pension funds, university endowments and foundations, have been vying to buy portfolios of European bank debt consisting of troubled commercial real estate mortgages. By acquiring these loans at deep discounts, they hope eventually to earn generous returns of 12 to 18 percent, investors and advisers say.
The asset sales in Europe could dwarf the work of the United States Resolution Trust Corporation, which was charged with disposing of the troubled mortgages resulting from the savings and loan crisis of the 1980s, said Russell Platt, the chief executive of Forum Partners Europe, an investment firm with headquarters in London. “Most of the firms looking at this came of age during the R.T.C.,” Mr. Platt said. “You can see why a lot of folks are rubbing their hands and saying: ‘This could be very interesting.’ ”
Commercial mortgage-backed securities, real estate loans that are packaged together and sold to investors, are not as common in Europe as in the United States. Instead, most European mortgages remained on the banks’ books, which has been a drag on profits.
As the sovereign debt crisis continues, European banks are expected to sell such distressed assets in an effort to increase their capital and protect against future losses. Morgan Stanley estimates that such institutions may have to cut their exposure to commercial real estate by up to $760 billion.
“Getting the banks healthy is critical for getting the European economy healthy again,” said Gifford S. West, head of European operations for DebtX, a loan-sale advisory firm.
So far, the pace of sales has been modest. Last year, the region’s institutions received an infusion of capital from the European Central Bank , easing the pressure to trim their balance sheets.
In 2011, CBRE, the giant real estate company, tracked more than 20 European loan portfolio sales with a value of 20 billion euros (about $26 billion at current exchange rates). The pace so far this year has dropped, with 14 transactions totaling 7.5 billion euros. Another 11 billion euros’ worth of loans are currently being marketed, CBRE said. Many individual loan sales are also taking place in private.
'the Market Is Opaque'
“The market is opaque,” said Ben Carlos Thypin, director of market analysis at Real Capital Analytics, a New York research firm. “There’s certainly more going on behind the scenes than is clear now.” The buyers have primarily been big names in private equity that are based in the United States — and are accustomed to taking on risk — including the Blackstone Group of New York, Lone Star Funds of Dallas and Colony Capital of Santa Monica, Calif. All are beefing up their presence in Europe, by adding employees, acquiring local real estate companies, or both.
The loan portfolios have mainly included commercial property in Britain and Ireland, often in what are considered secondary or even tertiary locations outside of the major cities. Two firms, Kennedy Wilson of Beverly Hills, Calif., and Cerebus Capital Management of New York, for example, are among the finalists bidding on a portfolio from Allied Irish Bank with 251 properties, including a string of provincial bars and nightclubs in England and a number of highly indebted hotels.
Kennedy Wilson, one of the most active buyers in this market, last year paid £1.3 billion, a 20 percent discount, for a portfolio of relatively high-quality Bank of Ireland loans in Britain. In June, the firm and its partner, Deutsche Bank, acquired a much weaker Irish portfolio from Lloyds Banking Group, for 360 million euros, a discount of 83 percent.
Once they acquire a portfolio, private equity firms often break up the loans and quickly sell them. For example, Lone Star bought a batch of assets from Lloyds Banking Group in December. Several months later, the private equity firm flipped one mortgage, a loan on a shopping center in Cornwall, to another group of investors.
Mary Ricks, who moved to London from California to run Kennedy Wilson’s expansion in Europe, said she would employ several different strategies depending on the specific loan. In some cases, the firm may opt to modify the terms of the mortgage, known as a workout, make improvements to the property, or foreclose.
Though a large proportion of the sellers have been British and Irish banks eager to rid themselves of mortgages outside their home turf, Ms. Ricks and other investors say banks in other countries will inevitably become more active. She said her company was opening an office in Madrid to develop relationships with Spanish banks. “Spain is our next target,” Ms. Ricks said.
Like their American counterparts, European banks have often extended loan terms in the hope that values will improve, a process that is known as “extend and pretend.” In addition, the European Central Bank helped ease some of the pressure on banks by pumping money into them.
Consequently, banks have been slower than expected to put their bad loans on the market and write down their losses. “We all sort of thought there would be a greater flow of deals,” Ms. Ricks said.
But in Europe, at least, no one these days expects the values of mediocre properties to rise without efforts to improve them physically or manage them better, said James Wallace, who writes a trade blog on European debt for the CoStar Group, a research company in Washington. “Extend and pretend is over,” he said. “People don’t say that anymore in Europe.”
As a result, participants in this market expect the pace of loan portfolio sales to accelerate. “We anticipate the next 24 to 36 months to be busier than the last 12 months,” said Graham Martin, the London-based global leader of KPMG’s portfolio solutions group, which advises banks on these transactions.
Ms. Ricks said business was already picking up. “The banks are under pressure at the top level,” she said. “They have to have deleveraging plans, and they have to execute them.”