Financing Property 2011 Our 23 rd annual series of presentations - PDF document

Financing Property 2011 Our 23 rd annual series of presentations Theme: “Two-tier market?” – Definitely not, multi-tier Prime Secondary Tertiary In the past, it has been a matter of misclassification Financing Property 2011 - Presentation contents • Three speakers (UK markets): – William Newsom The Property Finance Market – Mat Oakley The Commercial Property Markets – Lucian Cook The Residential Markets • Conclusions William Newsom Note: 1. Sweepstake sponsored by

The Property Finance Market - Contents • The market today • Issues with existing loan books • The outlook Acknowledgements I thank all those listed below for their time when I met them during May 2011, as well as “all” the German banks with whom we have day to day contact Anglo Irish Bank HSBC plc Aviva ING Real Estate Finance Bank of China Investec Bank of Cyprus UK JC Rathbone Bank of Ireland Laxfield Capital Barclays Capital Lloyds Banking Group, BSU Citigroup Longbow Real Estate Clydesdale Bank NAMA Coutts & Co. Nationwide Building Society Credit Suisse RBS GRG Development Bank of Japan RBS plc Duet Santander Handelsbanken Société Générale HSBC Private Bank Wells Fargo

The mountain of debt is larger than usually stated Source: All from DMU Outstanding senior debt secured against unless otherwise stated commercial property *1 £206.9bn Ditto for social housing £18.7bn Committed but not drawn £25.9bn CMBS (S&P and BoAML estimate) £56.0bn NAMA debt (UK at 35% of €72.3bn) £21.8bn Lending not captured by DMU research (estimated at 10% of *1 above) £20.7bn £350bn Contributors to the DMU research do not include: Ahli United Bank, Bank Leumi, BNP Paribas, Citigroup Global Markets, Close Property Finance, Credit Agricole CIB, Handelsbanken (100 branches), OCBC/Bank of Singapore, Ulster Bank, Unicredit, Wells Fargo How much of it is prime? What is prime? What is secondary? What is tertiary? • Definitions ebb and flow. In 2007 ‘everything’ was prime. In 2009 ‘prime’ was a rarefied product • According to the DMU research, lenders state that 38% of their loan books are secured against prime property • Surely, that is wishful thinking by the banks. I would say nearer 25% • That implies that c£250+bn of the total loan book of £350bn is secured against secondary or tertiary property • Which is huge

There are various different strata of secondary and tertiary loans Strata Description Financeable? Proportion (est.) Good secondary Some but not all of these: Yes 25% good bricks and mortar, good lease, good tenant, good location, good borrower. Otherwise, it would be prime Poor secondary Ticks fewer boxes Yes, selectively 25% Worse The focus here should be on property fundamentals: Never say never 50% (£100+bn) Tertiary location, condition, sustainable lettability. Vacant grot Opportunities to add Land value? Potential for change of use? In amongst all this, there are some hidden gems • I am inviting lenders to have an open mind about …… Lending against secondary (but not tertiary!) • Lending outside London • Providing development finance – where there are strong occupational • markets, e.g. central London spec offices But remember, it is about understanding the fundamentals, sustainable • lettability and careful stock selection (no apologies for repeating this)

… because, now is a brilliant time to be lending I’ve said that before and it still remains true 9.0% 8.0 2007 2008 2009 2010 2011 8.0% 7.0% 7.0 6.0% 5 year swap and interest rate margin % 5.0% 6.0 4.0% UK Base Rate 3.0% 20yr High Coupon Gilts 5.0 2.0% IPD All Property Equivalent Yield 5yr Semi-annual Interest Rate Sw aps 2007 2008 2009 2010 2011 1.0% 3 Month LIBOR 4.0 0.0% • Property yields remain high … • the cost of debt remains low … 9.50 7.0% 150.00% IPD All Property 6.0% 8.50 IPD All Property Equivalent Yield Equivalent Yield -0.7% 130.00% 5.0% Swap Rate and IPD Yield % Minus the 5 Year Swap Rate Sustainable Loan to Value 7.50 4.0% 110.00% 3.0% 6.50 90.00% 2.0% Sustainable LTV 5.50 70.00% 1.0% Cost of money (5 year swap + 0.0% 4.50 interest rate margin) 50.00% -1.0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3.50 30.00% 9 0 1999 1999 1999 1999 1999 9990 1999 1999 1999 1999 1999 2007 2008 2009 2010 2011 • the margin between property yields • and there is enough surplus income to and the cost of money remains high …. raise 90% LTV Sources: various 84% Prime Retail 82% Prime Office Where are LTVs and margins? 80% Prime Industrial 78% Secondary Retail 76% Loan-to-value ratio Now and going forward? 74% Secondary Office 72% Residential 70% Secondary Industrial Investment 68% 66% LTVs 64% • LTVs have been broadly static at 60%-65% 62% 60% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 for the last 2.5 years. Margins have been 290 280 broadly static over the same period, if not 270 Prime Office 260 Prime Retail 250 still moving upward 240 Prime Industrial 230 220 Secondary Office 210 Basis points 200 Secondary Retail 190 180 Secondary Industrial I don’t see LTVs and margins changing • 170 Residential Investment 160 dramatically for the foreseeable future due 150 Margins 140 130 to Basel III. Higher gearing would require 120 110 100 more regulatory capital 90 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2010 mid- year- year end 2.15 2.10 Prime Office Also, banks arguably are more interested in 2.05 • Prime Retail ICRs 2.00 Prime Industrial 1.95 1.90 Secondary Office income to interest cover (ICR). Min 1.50:1 Interest Cover (multiple) 1.85 Secondary Retail 1.80 Secondary Industrial 1.75 Residential investment 1.70 1.65 1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 1.10 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2010 mid- year- Source: De Montfort University year end

With LTVs stuck at 60%-65%, where’s the equity going to come from? The world is awash with equity • It comes in many different forms, obviously UK institutions, UK prop cos, • overseas sovereign wealth, German open ended funds, etc. • But not forgetting: – long term debentures – private placements. REITs. Perhaps raised in the US – accumulated wealth, family trusts, straight cash – refinancing after purchase – profits from trading; selling (and buying) at the right time – opportunity and value added funds. Funds raised in 2008 largely have not been deployed. £20+bn of purchasing power that has to be invested by 2012. Desperation? – mezzanine finance (see next slide) Many mezzanine providers have sprung up. There is definitely a place for them Fund Capital raised LTV up to Target return Cairn Property Debt Fund £75m 75% 7-8% BlackRock £87.5m 85% 10-14% M&G Mezzanine Real Estate Fund £122m n/a 12% Matrix Commercial Mortgage Fund £50m 75% 12% Duet European Real Estate Fund £170m 80% 15% LaSalle Junior Loan Program £200m 75% 8-11% Longbow/Alpha £64m/ 85% 15%/15-20% £100m Pramerica Real Estate Capital 1 £492m 83-85% 12-14% TOTAL £1.35bn Range 65%-85% Range 7%-20% • Other mezzanine providers include: AgFe, Blackstone, Brockton Capital, Davon Capital, Eurohypo, European Risk Capital, GIC, Maslow Capital, Och Ziff Capital Mgt, Partners Group, Pluto Capital / Mountgrange, Qatar Islamic Bank Source: Longbow, LaSalle and Savills

The returns sought by mezzanine and equity providers will influence property values • Mezzanine providers have a dilemma. Many seek IRRs in the mid to high teens+. They also seek prime deals. However, prime yields have fallen, such that the figures do not always stack up • What to do? Either reduce target IRRs (I have seen 8%), or venture into secondary territory • However, yields of secondary assets often are not high enough to produce the returns that the mezz and equity providers seek • Mezzanine and equity come in many different forms. Each will require its own level of return • If the figures don’t stack up? Secondary values may have to adjust (fall?) to reflect the required returns Issues with existing loan books The debt funding gap – estimated at £26bn • • LTV breaches – 80% in breach? Loan maturities - £100+bn over 2011/12/13 • Deleveraging - £100+bn (one third of the total loan book) • Notes from FPP 2010 1. The cost of unwinding swaps remains an issue, albeit less than it was 2. Obsolescence, lack of capital expenditure and lack of active management where the equity is under water remain an issue, indeed a big one