In the last quarter of 2010, with awareness that implementation was nigh, there was a flurry of speculative articles about the effect on the commercial property market of the much-debated regulatory instruments, Basel III (aimed at banks) and Solvency II (aimed at insurers).
Of banks, Neil Lawson-May joint chief executive of Palatium Investments said that “lending on good-quality, well-let real estate at moderate loan-to-value ratios (LTVs) makes sense … because such loans use relatively little capital and show high margins by recent historical standards (whereas) higher LTVs and loans on lower-scoring properties and developments use significant amounts of balance sheet and don’t normally return enough. “ He predicted that “there will be a noticeable difference between the fundability of good-quality versus secondary property, not just in terms of price but absolute availability of debt” and that “non-performing loan portfolios of secondary assets could be affected by the behaviour of the banks themselves, as their reluctance to lend against equivalent secondary property may drive down the value of those they have already lent against.”
He went on to say that insurers’ response to Solvency II and to the banks’ reluctance to lend could involve their placing “more emphasis on acquiring fixed-income and real estate assets (and possibly becoming) significant buyers of securitised debt, or even competitors to the banks, by starting up direct mortgage-lending businesses”. For both banks and insurers, though, “secondary property will remain unloved for a long time to come”. (Basel, Brussels and Berlin bureaucrats may yet force hand of banks, 29 October 2010)
Then market research firm Prequin announced the results of a survey which said that the new rules requiring higher capital buffers would contribute to 26% of European insurance companies lowering their commitments to private real estate funds and 16% of them stopping such investments altogether. Lawson-May was proved right when, to meet this large threat to commercial real estate activity, M&G and Matrix Group announced in November that they would be following AXA Real Estate’s lead in undertaking real estate lending. This introduced the concept of “mezzanine” funding to fill the gap between senior debt and equity. (reuters.com/news/archive/RealEstate, Nov/Dec 2010).
On Jan 4, AXA Real Estate announced that it aims to raise 1 bln euros in a debt fund “as it aims to take advantage of a shortage in bank loans to the commercial property sector.” It will also “consider investing across the whole capital structure — from senior loans to equity, including mezzanine debt, preferred equity and distressed debt structures — on a case-by-case basis”.( AXA targets 1 billion euros for property debt fund, 4 Jan 2011).
This is a great example of constraint producing innovation, but will it work? How will Basel III and Solvency II affect your involvement in commercial real estate? Have you already seen any impact? Let’s talk about it!