Sector Report: Real Estate Finance


By Vanessa Drucker

Real estate projects are getting capital injections from new and diverse sources as traditional bank lending dries up.


Banks around the world have become skittish about lending. Although central banks have flooded systems with liquidity, and capital is not necessarily always scarce, US, European and even Asian banks have grown stingy with construction loans for real estate development. In many countries, regulators have clamped down on risky lending exposure. Meanwhile financial institutions are still working through large losses on their books and trying to avoid further write-downs. With traditional lenders hugging the sidelines—and many in the throes of trying to reduce their property exposure—the void is beckoning to fresh players and alternative sources of financing.

There is a clear difference in conditions facing listed versus private property companies. Listed companies are still amply funded by available cash and existing bank lines, says Wilson Magee, director of Global REITs (Real Estate Investment Trust) for Franklin Templeton Real Asset Advisors: “Public companies can make development decisions without raising funds or obtaining traditional construction loans to take on activity.”

In China, for instance, Hang Lung Properties is developing large shopping malls from a net cash position, often using its own balance sheet. In Singapore large listed entity CapitaLand also “has several billion dollars in cash on hand,” Magee reports. In Australia, Westfield Group has been using bank lines and the unsecured bond market, with occasional equity, rather than bank loans. Since 2008 the main change for public firms has been more recourse to equity markets. On the debt side, Asian companies have been broadening their nascent Asian bondholder base and trying to tap more European and US investors.


Private developers, on the other hand, have been obliged to turn to a host of new sources for development funding. The litany ranges from opportunity funds, REITs (real estate investment trusts), hedge funds and sovereign wealth funds to pension consortia and family offices—private companies that manage investments and trusts for a single family.

There is a keen demand for new financing avenues, particularly in emerging markets. Anthony Sanders, professor of real estate finance at George Mason University, explains: “Developers are looking for innovative ways to spread money.” In places like Egypt, Venezuela or Mexico City, there is an urgent need for low-income affordable housing.

In the past, developers might have approached a big bank for direct loans. Now they must look elsewhere, as many big banks once involved in the market are reducing current exposures, cutting new lending—and in some instance getting out of the game altogether. Société Générale for example, is selling off property loan portfolios in the US and Europe; Commerzbank’s property arm, Eurohypo, has cut off new lending until next year; and Allied Irish Banks, Lloyds and RBS are all considering disposals of distressed property portfolios.

But alternate players are starting to take up the slack. Opportunity funds have long provided equity to property projects and continue to do so even in current markets. For example, GTIS Partners invested over $220 million in US residential housing this year, according to GTIS president Tom Shapiro: “Traditionally developers would have turned to community banks. Now we are providing unleveraged equity ourselves.”

Other opportunistic players have embraced debt transactions, such as mortgage or mezzanine loans, according to Jeffrey Temple, a law partner at Morrison Foerster in New York. He says: “They have woken up and discovered the debt business both in the US and overseas.”


Rogers, Integra: Family offices don’t fear a little risk, and they are not bound by restrictive regulations

In the US, REITs are also bypassing the banking system. These fall into two categories: Mortgage and traditional equity REITs, explains Sanders. As nonbanking entities, REITs are not subject to Federal Deposit Insurance Company (FDIC) or Securities and Exchange Commission (SEC) regulations. “They can lend at any rate to whomever they wish,” Sanders notes. Likewise, hedge funds, which charge higher interest rates than banks, are lending selectively—especially to “distressed” projects, or those that are valued at only a fraction of their initially projected assessment.

Sovereign wealth funds are still engaged in the Middle East and more active than ever in China, pursuing diverse types of projects, according to Magee. Although some of their funds are dedicated to early-stage construction projects, even more flow is going to income-producing assets—such as an office building that might already be as much as 97% leased. The Singaporean SWF is active in China, but Sanders suggests that it might slow its growth in exposure, as “they are nervous of a real estate bubble blowing up there.”

Over the past twelve months, pension funds have also boosted their role in property development financing. Some of the most substantial participants include the Government of Singapore Investment Corporation, several Korean and Canadian plans, and APG, the large Dutch pension fund. These institutions have lately tended to operate in consortia.

Typically, the pension plans might serve as an end buyer for a project, with agreements to take out the developer once construction is completed. Magee says: “GIC has always done development investment, but the Canadians and others are becoming more aggressive.”

“[Private] developers are looking for innovative ways to spread money”

— Anthony Sanders, George Mason University

Family offices represent another group with deep pockets. “Twenty years ago, they were likely to be run by family members and focused on safe bets,” says Jeffrey Rogers, president and COO of New York’s Integra Realty Resources. “After considerable wealth creation, they have become more sophisticated, hired professional managers and sought additional diversification.”

Most family offices already have some real estate exposure, and thus some familiarity with the sector. Although they generally gravitate to the equity side, some are now steering toward debt. “They don’t fear a little risk, and they are not bound by restrictive regulations,” Rogers adds.


But many of these alternative sources of financing carry a steep price tag. For example, private equity funds demand higher interest rates than banks do. Rogers notes that a bank might provide money at 5% to 7% in today’s low rate environment, whereas PE funds might require 10% to 16%, depending on the safety of the asset.


Magee, Franklin Templeton: Listed companies do not need to raise funds or use construction loans

Among those banks still lending, loan-to-value financing has gone from about 80% to 60% in the past few years. “Still, with LIBOR and Euribor so low, the terms are quite attractive against those reference rates,” Temple points out. Of course, it is difficult to obtain a loan in Europe or the US for any but top-tier properties in stable locations.

It is clear that the trend toward alternative real estate financing represents a common macro theme across global locations. Yet despite more-integrated markets, real estate remains fundamentally local, governed by inconsistent laws. For example, in Europe each country applies different foreclosure rules; in the Arab world, shariah law—which bans interest payments—requires unusual work-arounds; Japanese property, even after decades of deflation, remains very expensive. Notwithstanding each market’s idiosyncratic properties, the need for development capital is prompting new lenders to come up with innovative models to step into the breach.



Shapiro, GTIS: Brazilian condo projects often ran out of money

Projects in Brazil are financed differently from those in Europe and the US, because of the dearth of available capital and a legacy of relatively high interest rates. A US condo project typically starts with up-front capital; construction lenders then bleed money in during the building phase. In Brazil, however, neither debt nor escrow is available. Unit buyers put up 10% to 15% in cash deposits, making monthly installments thereafter. Thus, 70% of building costs are met by deposits and the remainder, by equity.

“In the past, they often ran out of money and would stop and start, while they sold additional units to increase deposits,” explains Tom Shapiro, president of GTIS in New York. When Shapiro spotted opportunity in 106 Seridó, an upscale apartment complex in São Paulo, he provided $100 million in equity capital to complete it. Prior to his infusion, in two years the complex had sold only 20 out of 128 units. “We were able to jump-start sales,” he says. “Buyers of large units wanted to see stability behind the project.”



Tough to find financing for data centers

When economic turbulence interrupts large-scale projects, private equity investors may have to ride to their own rescue. Data centers—which house mission-critical equipment for corporations and government agencies—require substantial capital to build, and involve large and sophisticated structures. When data center owner DigiPlex began expanding its existing $175 million data center in Oslo in 2010, the large Swedish bank Handelsbanken, which had provided debt financing for prior expansions in a 60%/40% debt-to-equity ratio, balked.

The company’s shareholders instead funded it with 100% equity. Only after construction was completed, with rents flowing, was the bank willing to increase its commitment. Even then, it only offered 30% debt-to-equity, less than half the earlier ratio. “Their unspoken message was ‘take it or leave it,’” says Byrne Murphy, shareholder and chairman of Digiplex.