Why debt won’t derail the property revival

Debt is currently an almost inescapable topic for the financial press: although it is more than four years since the credit crunch arose, the rumbling on of the crisis in the eurozone ensures the subject is still never far from investors’ minds. The balance sheets of listed property companies have fallen under scrutiny, as banks’ lending criteria are becoming more restrictive.

Having said that, the companies we are invested in own good quality properties and have had no problems with refinancing – banks, after all, want to have this type of loan on their books. The pressure on the banks is to reduce their exposure to loans made on low-grade properties where loan-to-value (LTV) ratios are high and rental growth prospects are weak.

Meanwhile, the Basel III regulations, which come into effect this year, impose tougher capital requirements on banks. In turn, this could lead to higher borrowing costs for property companies. As bank financing becomes more expensive, property companies are becoming more inventive as they seek alternatives.


Corporate bonds

Entering the corporate bond market, for example, is an option for larger companies with a relatively low LTV ratio. Bond issuance can give quick access to large amounts of capital. Flexibility is another major benefit of this process, giving the issuer independence and the ability to administer their portfolios dynamically. Bonds also offer the prospect of finance with a longer maturity, whereas the duration of commercial loans is typically much shorter.

Unsurprisingly, issues by property companies with fairly low yields and strong ratings are being snapped up by the market, with some heavily over-subscribed. Unibail issued a €750m seven-year bond in March 2012, which was 4.7 times over-subscribed.


Insure and go

Insurers are another source of funding, having recently increased their share of the real estate debt market to around 14 per cent. Shaftesbury took advantage of this shift by borrowing £120m from Aviva.

Investing in real estate debt is an attractive option for insurance companies, because it provides diversification opportunities and a secured form of lending. German insurer Allianz has recently expressed its willingness to get in on the act. Citing the plus points of low-risk transactions and attractive credit spreads, it envisages portfolios of commercial mortgage loans.

In the past, insurance companies were crowded out of the market by a deluge of cheap credit. However, there’s now a renewed opportunity for them to make robust returns from lending to the real estate sector.


Banking on it

Approaching the issue from the other side of the fence, banks are also being hands-on as they attempt to meet the Basel III capital requirements. As it happens, selling their poorer quality real estate loan portfolios is one of the techniques they are using to raise cash.

Some sizeable loan portfolios have already been sold to private equity players Blackstone and Lone Star, while AEW Capital Management and Starwood Capital have recently announced plans to construct debt funds which could have a combined spending power of over €4bn.

The debt void is therefore much less concerning when one considers that diverse borrowing opportunities with attractive lending rates are still available. The key is to remain focused on property companies with the best quality portfolios, where both occupational demand and financing will remain the most robust.

Vicky Watson manages the SWIP European Real Estate fund. The views expressed here are her own.