Europe Is Seen as Ripe Market for Distressed Property Loan Sales by Banks

European banks will be forced to sell more distressed commercial property loans in the coming year, as more borrowers default, said panelists at the Bloomberg Commercial Real Estate Summit.

“There’s going to be a feeding frenzy soon” for European loans, said Robert Blumenthal, a managing director at Deutsche Bank Securities Inc. “Someone’s going to have to take those loans out at a significant discount” and inject “huge amounts of equity” to recapitalize the assets, Blumenthal told the conference in New York today.

Mortgage investors Colony Financial Inc. and Starwood Property Trust Inc. (STWD) are among the firms seeking transactions overseas on expectations that delinquencies will rise and banks will dispose of more bad debt and make fewer loans in a weakening economy. European lenders have 151.4 billion euros ($204.8 billion) of commercial real estate loans in default, compared with $121 billion at U.S. banks, according to New York- based data provider Trepp LLC. Banks in the U.K. have the largest share of those loans, with 64 billion euros in delinquent debt.

‘They’re Very Concerned’

Europe’s fiscal crisis has roiled credit markets since July, causing gyrations in the value of securities tied to shopping malls, skyscrapers and hotels and leading to a pullback in loan originations. Issuance of commercial mortgage-backed securities in the U.S. has totaled about $26 billion this year. While that’s up from $11.5 billion in 2010, it’s a fraction of the record of more than $200 billion in 2007 when commercial real estate peaked, according to data compiled by Bloomberg.

“The Street’s not really taking risk, they’re very concerned,” Steven Schwartz, managing director of loan acquisitions for Torchlight Investors, said at the Bloomberg conference. “The first quarter’s going to be grim.”

In the U.S., it’s still difficult to get financing for commercial buildings outside of fully leased, prime properties in major coastal cities such as New York, Washington and San Francisco, the panelists said. They said the slowdown in sales of CMBS probably will continue in 2012, keeping CMBS sales to about $30 billion, or about the same as this year.

Because the CMBS market isn’t coming back fast enough to help borrowers refinance debt coming due, there will be a “huge increase” in U.S. hotel foreclosures next year, said Robert Sonnenblick, a hotel developer.

Replacement Debt

About $21.7 billion in CMBS loans on 232 hotels are coming due in the next 12 months and need to be refinanced, according to Realpoint, a securities ratings firm now owned by Morningstar Inc. (MORN) At best, a third of that will be refinanced, with many properties being taken over by lenders, Sonnenblick said.

Private-equity firms and real estate companies over the past six months have been staffing up in London in anticipation of bidding for distressed debt in Europe, said Glenn Rufrano, president and chief executive officer of brokerage Cushman & Wakefield Inc.

“They’re expecting in 2012 the one area of the world that will break in terms of opportunities” is the European region, he said. European banks need outside capital to solve the crisis, “whether it’s pure finance or it’s buying distressed loans. That’s where I see 2012. That’s where we want to be” providing services to loan buyers, Rufrano said.

REIT Inquiries

In August, JPMorgan Chase & Co., Wells Fargo & Co. and Lone Star Funds won the bidding for Anglo Irish Bank Corp.’s $9.65 billion portfolio of U.S. real estate loans. The sale followed a similar disposal by Allied Irish Banks Plc earlier this year.

While real estate capital markets have improved from the credit freeze in 2008, U.S. executives are still concerned about access to financing, Deutsche Bank’s Blumenthal said. He said he received calls over a two-week period during the past month from officers at every investment-grade real estate investment trust wanting to extend their unsecured lines of credit.

“A smart borrower is locking and loading all this liquidity,” Blumenthal said. “Why? Because all these CEOs are scared.”

Third-Quarter Slowdown

The U.S. commercial real estate market slowed in the third quarter as the sputtering economy and a pullback in debt financing limited deals. A total of $49.8 billion of commercial property changed hands in the period, down from $58.5 billion in the previous three months, according to Real Capital Analytics Inc. in New York. The 15 percent decline is the second-biggest since the first quarter of 2009, the real estate research firm’s data show.

Dune Real Estate Partners LP expects investment opportunities in the U.S. next year, said CEO Daniel Neidich.

“The flow from special servicers and banks has increased,” Neidich told the conference. Next year will continue “along those lines,” he said. One hindrance to European investing for dollar-based investors is the challenge of hedging currency risk, he said.

Most investors are focusing on major coastal cities such as New York, Washington and San Francisco, according to Leslie Wohlman Himmel, managing partner at Himmel & Meringoff Properties, a New York investment firm that owns and operates more than 2 million square feet (186,000 square meters) of office and retail space.

Chasing Yield

“That trend will stay, but some of that money will start chasing yield in the suburban markets,” she said.

Unlisted REITs are likely to be among the most active investors next year, according to Rufrano of Cushman & Wakefield.

Another popular strategy remains buying junior debt to get a claim on the underlying property if the mortgage borrower defaults, Deutsche Bank’s Blumenthal said. “Most of the inquiries are to get at an asset through the mortgage with the objective to loan to own or recap,” or get paid off at par, he said.

To contact the reporters on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net; Nadja Brandt in Los Angeles at nbrandt@bloomberg.net; Jonathan Keehner in New York at jkeehner@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net

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