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Property Funds, Bonds Supplant Europe Lenders: Mortgages

Great Portland Estates Plc (GPOR), the U.K.’s best-performing REIT this year, owed 60 percent of its debt to banks in 2010. Now, that same share of the London developer’s debts is held by bondholders and insurers that stepped into the market after banks reduced lending.

Property companies like Great Portland and Derwent London Plc turned to non-bank lenders while Hammerson Plc tapped the bond market to secure funding that’s cheaper and longer-term than bank loans, which typically mature in five years. For the new lenders and investors, the shift is a chance to earn returns as much as three times government bonds.

Great Portland “is taking seven- and 10-year money because we think underlying rates are at a good point in the market to be locking in today,” said Finance Director Nick Sanderson. The London-based developer and Liverpool Victoria Friendly Society Ltd. together agreed on a 10-year 80 million-pound ($130 million) loan from Canada Life Investments in July to fund their property venture.

More than 580 billion euros of property loans in the region mature this year and next, real estate broker DTZ estimates. With banks in Europe unwilling or unable to offer more than five-year loans, opportunities are expanding for non-bank lenders to offer commercial mortgages with maturities as long as 20 years. Axa Real Estate Investment Managers is raising additional funds while BlackRock Inc. (BLK) and Aviva Plc (AV/) are among other non-bank lenders that may lend as much as $75 billion for European real estate investment through 2013, DTZ estimates.

Returns Attract

Returns of 5 percent to 6 percent a year are the attraction, according to Nick Pink, European chief investment officer at Cornerstone Real Estate Advisers LLC. That compares with 1.73 percent yields for 10-year U.K. gilts.

Cornerstone expects to lend as much as 350 million pounds in the next 12 months with a focus on London and Southeast England, Pink said. The amount of maturing debt means new lenders can be selective.

“We’re not out there looking for potential borrowers who have nowhere else to go,” he said.

New bank loans for European commercial real estate fell by about 77 percent to 47.6 billion euros between 2007 and 2011, Michael Haddock, CBRE Group Inc. (CBG) research director, estimates.

Capital Requirements

European banks, which have as much as 2.4 trillion euros of loans outstanding to real estate companies, will cut that amount by about 25 percent as they work to meet tighter capital regulations under an agreement approved by the Basel Committee on Banking Supervision, Morgan Stanley wrote in a March report.

Deutsche Bank AG analysts including Paul Heaton wrote in a June research note that “now is the ideal time to enter senior real estate lending.” Risk is “at its lowest (represented by lenders able to negotiate lower loan-to-value ratios) and returns at their highest (represented by widest margins).”

Commercial real estate lending will develop “into the next big investment product as an alternative to investing directly into,” property said Natale Giostra, head of CBRE Group’s European debt-advisory unit.

Developers are also looking to the bond market for less- expensive financing as central banks globally push down borrowing costs, encouraging investors to seek higher yielding securities. Five European real estate investment trusts have raised almost 3.5 billion euros this month from bond sales, compared with 1.39 billion euros raised this year from the sale of commercial mortgage backed securities, according to data compiled by Bloomberg.

Bond Sales

Klepierre SA, Europe’s second-largest shopping center owner, sold a seven-year 500 million euros bond with a 2.75 percent coupon, while Hammerson raised 500 million euros with a seven-year 2.75 percent bond.

Great Portland raised $200 million in May from the sale of bonds maturing in 2019 and 2022. Its total debt including joint ventures was 740.3 million pounds through June compared with about 687 million pounds through March as it started developments and invested in its existing buildings, it said in a July statement.

From June 2011 through May 23, the developer agreed to 510 million pounds of new debt facilities that mature between 2007 and 2022, Finance Director Sanderson told analysts in a call that day. That raised its average time before loans mature from 5.2 years to 7.6 years, Sanderson said.

European commercial property prices fell 1 percent last year after rising 5.3 percent in 2010, according to data from Investment Property Databank Ltd., the latest available. That followed declines of 2.2 percent in 2009 and 15.9 percent in 2008 that left borrowers struggling to remain solvent and banks trying to sell soured mortgages.

Longer Mortgages

Insurers and funds are offering longer-term mortgages, allowing developers to refinance five-year bank loans.

Axa Real Estate, which loaned about 1.33 billion euros in the first six months of 2012, is raising additional funds to lend to property buyers, according to Isabelle Scemama, the company’s head of commercial real estate finance. The insurer has loaned or has the ability to provide about 5 billion euros of loans, typically for three- to seven-year terms, she said.

“Size is key because to be active on this market you need some investment capacity,” Scemama said.

Blackrock may raise funds to give direct loans to European commercial property buyers, spokesman Marc Bubeck said in an e- mail. Schroders Plc (SDR), a London-based fund manager, may set up a similar fund, according to a person familiar with the matter who declined to be identified because the decision isn’t final. Schroders declined to comment in an e-mail.

Lending Expands

Canada Life, the Great-West Lifeco Inc. (GWO) unit that made the loan to the Great Portland venture, is “actively expanding its loan book,” real estate finance director Nicholas Bent said in a July 18 statement. The 10-year loan, at a rate of 3.7 percent a year, is secured by 12 shops on London’s Oxford Street, the U.K.’s busiest shopping strip. Great Portland has risen about 40 percent this year, the FTSE 350 REIT Index (F3REITS)’s best performer.

Lenders and borrowers have realized that the typical five- year bank loan for income-producing real estate is short, Cornerstone’s Pink said. The Massachusetts Mutual Life Insurance Co. unit, will offer loans for as many as 20 years, he added.

Borrowers “probably want a balance of maturities and a balance of different debt providers,” Pink said.

As property prices boomed in Europe through 2007, “people were borrowing money without looking at the term of the loan because it was always rolled” over and replaced with new debt, Irish developer Simon Kelly, who together with his family owes banks 800 million euros, said in a phone interview. Now, borrowers who take out a four-year loan “have to start panicking about it after two years,” he said.

‘Diversified Funding’

Derwent (DLN), another London developer, borrowed 83 million pounds for 12 years from Cornerstone in August at a fixed rate of 3.99 percent a year. The loan margin was 210 basis points over the gilt rate, Derwent said in a statement at the time.

The new loan “provides a diversified source of funding for Derwent at a modest all-in interest rate, taking advantage of the recent falls in gilt rates,” Damian Wisniewski, the company’s finance director, said in the statement. “It also enhances our debt-maturity profile.”

Aviva, the second-largest U.K. insurer, provided South African billionaire Nathan Kirsh with a 145 million-pound loan with a 20-year term in February to fund half the acquisition of Tower 42, the first skyscraper built in the City of London financial district.

Raising Cash

The number of funds raising money for real estate lending in Europe rose 66 percent in the first six months of 2012 compared with a year earlier, according to research from Indirex Ltd., which compiles data on real estate funds that aren’t publicly traded. While they initially focused mainly on the U.K., Europe-wide funds are more popular now, according to Gary McNamara, business development director at Indirex.

“A lot of guys have formed debt funds and are really trying to capture that market,” Keith Breslauer, founder and managing director at private-equity firm Patron Capital Ltd., said in a telephone interview.

Patron raised more than 880 million euros in September to buy distressed property and real estate related companies in Europe. It has yet to borrow from a debt fund and may do so in the future, Breslauer said.

Fundraising Delays

Junior and mezzanine lenders, who can demand higher returns than senior lenders because their loans rank lower in repayment priority, have raised about 5 billion pounds to lend to real estate investors in the last two years, Giostra at CBRE estimates. Junior lenders are achieving internal rates of return of 8 percent to 11 percent a year, an annualized measure of performance used by private-equity managers, said Giostra, and mezzanine funds are targeting IRRs of 12 percent to 15 percent.

“Fundraising on some of these debt-fund vehicles is taking longer than expected,” Hans Vrensen, DTZ’s global head of research said in an interview. “It may be a little delayed, the amount raised may be a little bit lower in the short term” because some investors are still risk averse, he said.

Much like the developers seeking to extend debt maturities, lenders like Cornerstone are taking a longer view. Providing loans for real estate investment “is a long-term opportunity for an organization like ours,” Pink said.

Lenders will take “logical low-risk steps while everybody is getting comfortable with a new investment class in a new geography,” he said.

To contact the reporter on this story: Neil Callanan in London at ncallanan@bloomberg.net.

To contact the editors responsible for this story: Andrew Blackman at ablackman@bloomberg.net; Rob Urban at robprag@bloomberg.net.

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