September 14, 2012 / 11:08 AM / in 5 years

Analysis: Insurance funds no cure for Europe's property credit crunch

LONDON (Reuters) - When John Feeney, head of real estate debt at Henderson Global Investors, agreed to speak at a conference earlier this year, he was pressed to say how insurers would rescue Europe’s credit-starved property industry.

“I told them it was a fairytale,” said Feeney, who is setting up funds targeting insurers that want to lend on property deals. “I felt toxic after that. Nobody approached me and I was left standing alone with my drink.”

As banks have drawn back from a sector sullied by the sub-prime crash and resulting global financial crisis, hopes that insurers and other non-bank lenders will plug a significant part of the hole left behind are proving forlorn as they are unwilling to go where banks now fear to tread.

Lack of lending is a debilitating problem for the property industry and the global real estate funding gap, the difference between the debt in need of refinancing and the funds available, will be $216 billion over the next two years, with Europe accounting for 84 percent, property consultancy DTZ said recently.

Proposed changes under the European Union’s Solvency II insurance industry directive that make it financially more attractive for insurers to provide debt to property mean the likes of Aviva (AV.L), Prudential (PRU.N) and Legal and General (LGEN.L) have recently indicated that they will open their cheque books.

Returns of 4 to 5 percent beat yields on the safest European government bonds and real estate brokers Savills (SVS.L) and CBRE (CBG.N) said insurers could account for 20-25 percent of UK lending in the sector.

In June consultancy Oliver Wyman also urged insurers to help stabilize the European economy by ramping up lending, but there is a growing sense their impact will be minimal. Developers complain that insurers are understaffed and only lend against the kind of top-quality real estate many banks still do.

Typically staffed by less than a dozen people, many insurers property lending units are dwarfed by the 100-plus strong teams the banks had in the profligate years before the crash.

“It helps in one or two niche cases but not the vast majority of the industry that isn’t in the uber-prime market,” said a senior executive at a large British listed developer who reckons insurers will probably account for less than 10 percent of the market.

Many insurers only make loans above 75 million pounds ($121 million), with a preference for less risky fixed-rate debt and buildings with financially secure tenants in locations outside wobbly markets like Spain and Italy.

They will also typically lend up to 60 percent of the property’s value, largely in line with the banks, which means a greater chance of getting their money back if the value falls.

“The real problem is finding debt at between 60 and 70 percent of the property’s value where returns are between 7 and 8 percent,” said Philip Cropper, managing director of real estate finance at CBRE.

“We are not going to be the saviors, the market must get that straight,” Legal & General Investment Management’s (LGIM) head of commercial lending, Ashley Goldblatt, told Reuters, describing forecasts they would account for 20-25 percent of the market as “overly bullish”.

LGIM chose to do a 121 million-pound deal with student housing specialist Unite Group (UTG.L) in May after weighing up close to 200 other prospective loan deals. “You don’t go out with the first person you meet but someone that meets your high standards. That’s a reasonable metaphor for the way we look at lending,” he said.

Other forms of non-bank lending also favor bigger investors, said Patrick Long, managing director of real estate at bank Lazard. It will widen the gap between “winners and losers”, he said, with smaller companies having to rely on banks while larger listed property companies and private equity investors like Blackstone (BX.N) able to access credit elsewhere.

The alternatives include the bond market, private placement debt market and commercial mortgage-backed securities (CMBS), a form of securitized debt backed by property that banks favored before the crash as it shifted loans off their books.

    But the bond market is open mainly to only the listed companies because it requires them to have a credit rating and there is an investor aversion to all but the safest CMBS because of their similarities to instruments like collateralized debt obligations, sub-prime versions of which poisoned the world’s financial system.

    “It will result in a very two-tiered property market in Europe,” Cropper said. “Good assets will perform well but the bad will take an awful long time to recover and some of it will never recover at all.”

    The theory of fewer larger players is borne out by data from researcher Real Capital Analytics. In the last year 12 investors bought property across the UK, Western Europe and central and eastern Europe, compared with 28 in 2008, on a list dominated by Qatar and private equity giant Blackstone.

    The debt funding gap will also remain high in Europe as banks fail to mark down their loan books as aggressively as their U.S. counterparts, Cropper said.

    “In the States you had a government-backed agency to buy in the loans so they marked to market a lot quicker. In Europe it’s a balancing act as banks try to preserve capital, so it won’t be resolved quickly.”

    Few expect a fully normalized lending market within the next decade. As the banks gradually unpick the mess, insurers will proceed with the same level of caution, said one lawyer who specializes in property debt deals.

    “Insurers will lend, but they won’t be the ones sweeping up the shit,” he said.

    (Editing by Greg Mahlich)

    brenda.goh@thomsonreuters.com; +44 020 7542 2230; Reuters Messaging: brenda.goh.thomsonreuters.com@reuters.net

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