Real estate debt funding globally is a huge machine – turning over $400bn annually in the US, and approximately €225bn in Europe, of which the UK makes up roughly 25-30%. The European figure, however, is a very broad estimate because at any point in time, debt investors (lenders) and borrowers have no clear measure of available capital in the market or solid statistics on overall transactions from which to benchmark activity.
In this respect, CRE debt is an anachronism of the modern investing world.
The UK and Germany benefit from reports produced by De Montfort and Regensburg Universities – much re-quoted market studies, but reliant on lender co-operation and self-certification. An institutional grade benchmark and loan level data are still a long way off. This is in stark contrast to the USA where such data is available and increasingly detailed and tech-enabled. As this disparity grows, it may become a material barrier for global capital choosing between the two markets.
At a time when growing pension and insurance funds are targeting CRE debt, and in a world of smart solutions, major changes in market transparency ought to be afoot, yet change in Europe has been notably slow.
Structural barriers
The barriers to transparency start with the regulatory environment. Lending against commercial real estate is not in itself a regulated activity, and debt investors are subject to different scrutiny depending on their organisational structure. The most regulated end of the spectrum is UK banks, where the Bank of England has power to collect information and require capital to be held. Debt fund managers may be required to be AIFMD compliant, but other lenders may not have to report their activities to anyone. No single body is therefore authorised to collate information.
As the market has become more diverse, so the job of understanding who is in it, and what is transacting is more challenging. NDAs, signed by borrowers, lenders and advisors to loans make third party discovery difficult – as witnessed by often inaccurate press reports about financing deals. In contrast, the USA has much more loan level information, available from the CMBS and traded debt markets, giving a base from which the market can gather information. Huge strides have been made in data availability, although whether every lender welcomes terms being made public is probably a moot point.
Does it matter?
Not everyone is desperate to see change, arguing that the market functions well despite its information asymmetry. In a decade, the UK has moved from bank dependency towards a healthily diversified base of lenders financing a wide variety of real estate projects without tech intervention.
Lenders are not pushing to change the status quo, and regulator calls for an industry-wide loan database have met pockets of resistance. Perhaps this also reflects the fact that those holding biggest positions – large lenders – benefit from this opacity, as the ‘one-eyed in the land of the blind’. Their stance seems to be softening to acceptance, but whilst there is now a consensus in favour of transparency, there has been no clamour for it to happen.
The skew has, perhaps, also benefited larger borrowers – who avail themselves of cheaper funding as risk-averse debt investors flock to parts of the asset class they know best. In the past five years, the difference in cost of debt capital between big and small property investors has widened markedly, with cheap funding from bond markets available to the ‘haves’ giving a massive profitability boost.
What’s wrong with relationships anyway?
Currently an FD needs to put a lot of time into ‘working debt relationships’ both to gather information about the market, and socialise his/her business within the lending community. This helps ensure that when an acquisition arises, lenders are warmed up, and know they are next in line – although borrowers often find managing a credit process alongside an acquisition timetable slightly sweaty. The other key feature of a relationship-based approach is in managing the unexpected, and the proven benefit of knowing the right people in an organisation to smooth things by when plans change.
While solutions people will criticise this highly inefficient way to market-match, many borrowers speak warmly in favour of it – perhaps reflecting the virtuous circle of clubbable personalities who attend events and do business with one another.
There is a logic to RM based business, however, when considered alongside the idiosyncrasy of every property financing. Assets, cashflows, sponsors, business plans and the wider relationship all interact variously to produce the commercial terms under which a deal is done. The interplay of hard and soft factors which attend every decision means no one I talk to believes that an algorithmic borrower/lender match is going to get a better outcome – at least at this point in time.
How would transparency benefit us all?
Despite the imperfections of categorising real estate loans or debt capital availability, it must be an enterprise worth pursuing to create an environment which is as well understood as it can be, both by lenders and borrowers.
The regulator has shown a very public interest in the issue, and is supporting the industry to find its own solution rather than extend regulation. If the industry accepts its inevitability, then it should grab the chance to find its own solution rather than respond to policy intervention. The information problem will allow new ideas to evolve, and marry category imperfections with neater ways of thinking and organising information. I look forward to seeing how the project will shed new light on the sector, helping it manage its capital pool more efficiently.
An exciting time is in prospect. New tech initiatives are hitting the inbox weekly – and whilst the winners have yet to emerge, it feels that the industry is ready to accept and look seriously at change. No doubt in a decade we will look back and wonder how we ever managed in 2018.
