For all of the geographical, economic and political differences that have always existed between the real estate finance markets in the U.S. and Europe, current conditions in both share a common catalyst. The collapse of Lehman Brothers, the U.S. investment bank, directly and indirectly unleashed a tidal wave of events that would profoundly impact the global economy and cause the value of real assets (including real estate) to plummet. Many banks in the U.S. and Europe with high levels of exposure to commercial real estate (either directly through loans or indirectly via derivative products such as commercial mortgage-backed securitisations) effectively went bust, requiring state bailouts or to be forced into merging with other (supposedly) stronger banks. The U.S. government was forced to bail out both Fannie Mae and Freddie Mac, banks with long and glorious histories were brought to their knees on both sides of the Atlantic and, in the case of some countries such as Ireland and Portugal, entire economies needed bailing out to avert collapse.
Several years on, how has real estate finance in U.S. and Europe recovered, and what trends have emerged? Has the financial shock of 2008 brought the real estate markets closer together or driven them further apart?
One of the defining characteristics of the European REF market over the past few years has been the emergence of non-bank lenders (NBLs). It is estimated that between January 2008 and mid-2013, the top global 50 private equity NBLs raised nearly U.S. $200 billion to invest in real estate through debt and equity, and 2014 is forecast to be the biggest year yet in terms of capital raising. Much of this capital has been deployed in Europe because the banks were slower to recover in Europe than in the U.S., creating a liquidity shortfall.
NBLs were enthusiastically lending when banks were severely restricted in lending into real estate. In addition, other structural differences give advantages to NBLs which promise to keep them significant players in the real estate finance market, at least in Europe, even as the traditional lenders re-enter the REF market in force. Borrowers appreciate the more streamlined credit processes of NBLs, unencumbered by the many-layered credit and approval processes banks have constructed over time to mitigate risk. A recent survey from Lloyds Banking Group (a UK bank) highlighted investors’ perceptions that NBLs are by a significant degree regarded as more innovative, faster in service and more prepared to accept risk. NBLs will also often take an equity investment as well as debt, cementing the view that NBLs take more of a partnering approach to investing than banks. In Europe, NBLs have been more agile in identifying and plugging gaps in the REF market, such as providing mezzanine and senior debt or demonstrating more flexibility as to structure and repayment profiles.
The emergence of the NBLs in Europe has been underpinned by the on-going travails of the banks. Many European lenders have spent the last few years cleaning up their balance sheets, shedding enormous amounts of real estate-backed loans — the bonanza in trades in non-performing loan portfolios is testament to this. However, for many banks across many countries, this is far from complete. Bank liquidity for REF deals in certain markets is still very scarce, creating opportunities for NBLs, especially in ‘non-core’ cities and regions which are considered unattractive to mainstream lenders.
How does this compare to the U.S.? The crisis of 2008 was as bad for U.S. banks as it was for Europe’s, but how have they recovered since then? Are NBLs as much as force across the U.S. as in Europe?
In the U.S., although there was a level of paralysis among banks in 2008/2009, U.S. banks quickly began to address problem real estate loans and deleverage balance sheets. In addition, banks that did not have significant real estate exposure saw an opportunity to expand into the commercial real estate market and take market share from banks who were struggling. Although many NBLs were established in the U.S. over the past several years, they quickly found themselves facing fierce competition from banks with a lower cost of capital. The competition is particularly noticeable in gateway markets, such as New York City. This forced the NBLs to focus on non-gateway markets where lending and real estate values were slower to recover.
However, the U.S. CMBS market is also experiencing a significant rebound. In 2009, the CMBS issuance volume in the U.S. was less than U.S. $3 billion, and in 2014 it is projected to exceed U.S. $100 billion. As a result, NBLs are now facing significant competition in non-gateway markets from CMBS originators. One bright spot for NBLs in the U.S. has been in the residential mortgage market, an area where commercial banks continue to decrease exposure. In addition, a number of NBLs are eyeing the looming wave of loan maturities from the CMBS heyday years of 2005-2007 when more than U.S.$600 billion of CMBS loans were originated.
NBLs around the world also face the prospect of increasing regulation: As NBLs increasingly undertake functions akin to banks (so-called shadow banking), so more regulation becomes inevitable with separate reviews are being undertaken in the U.S., the EU and the UK. This increased regulation will undoubtedly reduce the competitive advantage of the NBLs compared to the banks, strengthening the hands of the banks still further.
The U.S. and Europe have for centuries revelled in their differences. And, whilst the real estate finance markets in both the U.S. and Europe suffered equally following the collapse of Lehman Brothers, it would appear the real estate lending markets have recovered in different ways. Traditional lenders have bounced back more quickly in the U.S., limiting the opportunities for NBLs, resulting in lots of U.S.-based NBLs scouring Europe for transactions.
U.S. investors in Europe quip that what happens in the U.S. market will be seen in Europe four to five years later — it will be interesting to see whether this will also apply to the resurgence of bank lending in the real estate finance market.
By Matthew J. Heaton, Jeffrey S. Page