Europe’s two-year $82bn commercial real estate funding gap will shrink by more than half by the end of next year while the UK’s $36bn financing gap will decline by three quarters over the same period before virtually evaporating by the end of 2015, in a remarkable conclusion by DTZ’s latest Funding Gap research.
According to DTZ, the UK’s funding gap – the net difference between the estimated aggregate debt maturity profile of all outstanding property debt and available finance – has reduced by 55% in the last six months, the largest constituent of Europe’s broader 20% reduction.
The dramatic estimated collapse and remarkably swift evaporation of such an enormous financing gap across Europe is the probable scenario, according to DTZ, in the context of a continuing rise in non-bank lending, no further negative regulatory requirements and continued low interest rates.
DTZ forecasts that insurers and debt funds will provide a combined $225bn over the three years from 2013 to 2015, with 70%, or $157.5bn, targeting pan-European commercial real estate.
Nigel Almond, head of strategy research at DTZ – and author of the Funding Gap research – wrote: “It is now five years since the onset of the financial crisis in 2008. Whilst the deleveraging process was slow to start we have seen the momentum building since 2011.
“If these trends continue, we project that over the next three years, by year-end 2015 the European debt funding gap will be largely resolved. The UK’s gap will most likely be gone earlier than that.
“We do, of course, expect there to be a longer tail-end to the process, with some 10-15% of the remaining funding gap taking a longer period to work out as evidenced in previous cycles.”
DTZ said the onerous impact of regulatory requirements – including the 9% core tier one ratio threshold, Basel III and Solvency II – more than doubles Europe’s two-year funding gap to $190bn. France, Germany and the Netherlands are estimated to likely suffer most from incoming regulation.
But the net effect of insurers and debt funds’ aggregate new lending, as well as increased capacity in corporate bond markets, has increased debt finance by an estimated 45%, almost canceling the impact of regulation-driven capital erosion to a near net neutral level, claims DTZ.
DTZ’s Funding Gap research is extremely influential but has its detractors, who argue that the conclusions rely too heavily on imperfect knowledge and a series of assumptions for which there is a wide margin of error.
Hans Vrensen, global head of research at DTZ, said at last night’s preview of the Funding Gap research: “We operate in an imperfect world with imperfect transparency which requires us to sometimes make bold assumptions in our approach.
“If we didn’t do this, it would not allow us to draw the conclusions we need to come to a clear, practical and actionable market view that our clients have come to expect of us.”
DTZ’s conclusions are much broader than the headline funding gap estimate, offering much wider market insights.
Europe’s now has 10 active insurance companies lending to commercial real estate and more than 30 funds operating, or capital raising with the intension of providing senior and mezzanine debt, which have an available lending capacity of $75bn in the two-year period to the end of 2013, estimates DTZ.
In addition, the continued growth in corporate bond issuance will provide an additional $29bn of net new funding. This year, there has been €11.5bn in corporate bond issuance across Europe, projected to close the year at circa €15bn – with the same final year figure estimated for 2013.
Almond wrote: “In the near term, we expect two-thirds of the non-bank activity to come from insurance companies. But, the growth in fund raising by fund managers should see a more even balance in lending capacity by 2015.”
In its fifth bi-annual Funding Gap update, DTZ factored in the impact of mismatched interest rate swaps. Long-dated swaps were commonplace in real estate loans, both securitised and bi-lateral, ultimately driven by their profitability for banks and cheaper original all-in cost of debt for borrowers in an effort to hedge against future interest rate increases.
Since the 2006, interest rates have fallen and and kept artificially low by central banks in response to the global financial crisis and, as a result, leaving borrowers with often enormous erosive liabilities in financed real estate deals due to swap terms of up to 30 years, ranking either pari passu or senior to the commercial mortgage.
Assuming 25% of 2006 and 2007-vintage European property loans – €60bn – were mismatched, and an average 15% swap breakage cost, DTZ estimates the total liability would be €9bn, increasing Europe’s €82bn funding gap by 6%.
Almond wrote: “However, given that most loans with longer swaps are likely to be extended further any way, any limiting the defaults during the loan term and potential for moving the market more towards fixed rate lending. systematic market-wide additional indebtedness due to the swap mark-to-market charge will reduce over time.
“Therefore, we disregard it in our final estimate of the debt funding gap.”
Based on DTZ’s research, there is $9bn of lending capacity in UK, rising to $17.5bn next year comprised of $13bn from insurers and debt funds and $4.5bn from corporate bond issuance.
In Europe, the total is estimates at $12bn for 2102 and $38bn next year.
In the near term much of the non-bank lending will come from insurance companies, which currently account for two-thirds, estimated DTZ and forecasts that debt funds will overtake this dominance by 2015 with a seven-fold increase to $48bn compared with $43bn.
Almond wrote: “The current shift towards a more diverse lending base across Europe is a welcome shift in the market. The dominance of banks as a source of finance in Europe is a stark contrast with the US where non-bank lending represents around 40% of the market.
“With no debt funding gap, this highlights how markets can operate more efficiently when there is less reliance on one source of finance.”