The second main theme is intrinsically linked to the first – banks are unable to lend as much money as they would like. Banks are sitting on increased property finance budgets but cannot put the capital to work due to either an unwillingness to lend against such lofty values or, more likely, they are losing out to competition (whether that comes in the form of other lenders or their clients being trumped by other bids). Putting these themes together, there are two incredibly large sources of capital, both debt and equity, that are not working as hard as their managers would like.
So what is the solution to this conundrum? Well, Bankers, you will be pleased to know that there is something which can be done. By you. At a basic analytical level, the root of the gridlock outlined above can be traced back to supply/demand economic theory. Increasing the supply of property available, will provide more possibilities for investment (and therefore lending) and should serve to regulate the property market prices – thereby acting as a check against any asset “bubble”.
As values plummeted and LTV covenants were tripped during the recession, many banks chose to stand by their clients as the loans, on the whole, were still performing. However, in some cases, assets were handed over to the banks as the equity values had vanished. In both cases, these assets are still held by the banks who, understandably, have been unwilling to crystallise their losses. These assets hold a key to unlocking value for lenders and investors alike. By releasing these assets onto the market, banks could receive an equity injection as well as further drive (indirectly) their lending business. They would clean up their balance sheets whilst simultaneously improving their profit margins.
This approach is not without its hurdles. Clearly the drip feeding of assets into the market place would need to have a sensible and commercial approach as flooding the market would distort property prices too much in the opposite direction. There is also the realisation that, by adopting this strategy, the banks will run the risk of decreasing the value of their own property holdings as property yields adjust outwards due to increased supply. Lastly, banks could be forgoing a great deal of value by so doing. However, it is a necessary step for the long term health of the property industry and lenders stand to gain as much from this as investors over the long haul.
A sensible way to coordinate this would be through some bank/investor JVs. A partnership such as this has numerous advantages: it affords the banks in question the possible upside should values continue to improve over the longer term (and therefore makes the proposition more attractive to the banks’ in question); it makes the portfolios on offer more digestible for investors – and therefore more financeable which allows the project to get off the ground. Of course, this would mean that the equity tickets are still relatively small – for example on a £250m portfolio split on a 50:50 basis, the investor would still only deploy about £44m assuming a 65% LTV on his piece. However small these steps may seem, when added together the cumulative benefit could be significant: by so doing, another facet of the real estate market will open up and the industry can continue its renaissance on a more solid footing.
Lenders have been under increasing pressure to demonstrate that they are willing to work with investors throughout this recent period in the market. They have done this to an extent during the peak of the recession, but now that the financial storm is over its worst, it is time to take this concept of “partnership” to the next level. Investors will be wary – understandably so – but they face their own pressures in terms of deploying capital. Their asset management expertise is valuable and so is their capital. By joining forces with asset holding banks, there is huge potential for upside for both groups.
Dominic Wilson
Former Head of Debt
AEW Europe, London
