Real Estate Forum - January 2013

NEWS FRONT
Euro Bank Cuts Spell Opportunity

NEW YORK CITY—The New York Post recently reported that European banks were planning to cut their lending volume by a whopping US$175 billion. That spells good news for lenders who can swoop in and fill that gap. And that’s exactly what Newark-based Prudential Financial Inc. intends to do.

In an exclusive interview after Pru’s
Tuesday morning Global Economic and
Retirement Outlook briefing, David M.
Durning, senior managing director of
originations and agency lending for Pru
Mortgage Capital, told GlobeSt.com that
the firm is pushing into Europe. “The
bank pull-back is a perfect opportunity for
senior lenders to broaden their trade in
Europe. They’re a scarce commodity.”
For fixed-income investors, he contin-
ued, “it also represents a yield opportunity
versus what they could get in the United
States.”
As in the US, “some markets are more
stable than others in the Eurozone,”
observed Jack Taylor, managing director
of global real estate finance, who
explained that on the fund front, Pru has
had a footprint in Europe for years. “The
risk/return is an opportunity for many
investors.”
But while the lending cutback under-
scores the dire straits of European capital
flows, it also highlights the willingness to
swallow bitter pills. As was discussed dur-
ing the briefing, the Eurozone crisis is
actually a bit more secure than it was a few
months ago.

John Praveen, managing director and chief investment strategist for Pru’s International Investment Advisers, pointed out that all of the factors that drove markets in 2012 are still in play. And with Germany committed to keeping the Eurozone afloat, the worst might really be over for the European capital crisis.

As the report issued by Pru stated, “The developed world economies continue to be weighed down by a variety of structural factors, but as time passes and we gain greater distance from the financial crisis, we see signs of healing.” There is the possibility, though, that “the Eurozone crisis could intensify again. The political progress has been slow, but we think things are headed in the right direction.”—John Salustri

The Brave New World for RE Funds

A new and increasingly challenging environment is emerging within the real estate private equity funds sector. Consider the current climate. In most markets, deal flow remains slow, largely because of continued illiquidity in the capital markets. Fund-raising poses an enormous challenge because investors are wary of making commitments, especially to new funds. In addition, the number of active funds is contracting and will likely continue to do so for some time yet.

Add to that the sweeping regulatory changes coming into effect in the US and significant structural and cultural shift.

The good news, for those able to move beyond the old rules, is that this a period in which funds can thrive. Lack of available bank debt means that deal flow is slowed to a trickle outside of gateway cities in North America and northern Europe. However, this has created new investment opportunities in the funds world.

Looming final loan maturities and broken capital structures on a large number of assets have fueled demand for refinancing capital. Indeed, a recent survey of private equity funds we conducted revealed that refinancing is expected to be the most lucrative opportunity for deploying capital in 2013, followed by bank portfolios and non-core assets.

The sector has picked up on other innovative investment opportunities as well, including secondary trading of positions in closed-ended funds. Not only have opportunistic investors found new investment potential in this space, but the trend could also help restore the confidence of skittish core investors by providing flexibility.

Additionally, senior debt funds are gaining momentum, especially in markets where bank lending for real estate is heavily restricted by regulation, like China. Raising funds, however, is still tremendously difficult. Eighteen months appears to be the new norm for achieving a final close.

This new environment is forcing funds to think differently about their business vis-à-vis investor relations and how they pursue deals, and it is also causing re-examination of internal operational strategy. The pressure here is being imposed by tightening regulatory standards in the US and Europe. Alarmingly, although fund managers are facing significant near-term compliance requirements from these directives, almost 40% of those surveyed still did not know what business costs they would incur to meet them.

Fortunately, new solutions are emerging to help ease the process by offering ways to improve operational efficiency and reduce costs. Increasingly, software and administrative service providers are building out platforms that are specifically designed for real estate. Outsourcing and off-shoring back-office functions are also on the rise in the funds world.

Uncertainties still loom over the real estate private equity funds sector. In recent years, many funds have either opted out or been forced out of the space because of them. For those that have persevered, ongoing success in today’s changing climate is achievable, but it will depend more now than ever on their adaptability and creativity.

By Howard Roth

(A longer version of this column originally appeared on GlobeSt.com.)

Howard Roth is Ernst & Young’s Global Real Estate Leader and a partner with Ernst & Young LLP’s Real Estate practice. He may be reached at howard.roth@ey.com. The views expressed here are the author’s own.