EBS REMI and CORESTATE Capital AG Launch “Distressed Real Estate Debt” Research Cooperation

Approximately 1.4 trillion Euros worth of global distressed assets are being marketed, while another 1.2 trillion Euros of commercial real estate mortgages worldwide are due to mature over the next four years, with approximately 500 billion Euros in Europe and 125 billion Euros in Germany alone. “Banks have severely cut back on credit financings and focus, if any, on low-risk lending. This trend is set to accelerate further and will lead to a sharp increase of non-performing real estate assets. Banks are not capable of covering financing demand due to the capital requirements they are facing. Real estate debt, as we know it, is in the past and no one knows what implications this has for the real estate market (The New Normal),” said Ralph Winter, Founder and Chairman of Corestate Capital AG. These developments have been driven by lending restrictions of banks who, in order to ensure their own economic survival, are either avoiding loan extensions or are making them subject to increased equity contributions or much higher risk premiums. “The main aim of our research cooperation is to analyse the upcoming wave of distressed real estate debt and to provide transparency which will help the real estate industry cope with the greatest financial crisis since World War II.”

“The “Distressed Real Estate Debt” research cooperation went live on 1 November 2011, in order to analyse the parameters of the market for distressed real estate assets and non-performing loans, to predict future developments, and to investigate the problems emerging on the ground,” stated Prof. Dr. Nico B. Rottke, Founder and Head of the Real Estate Management Institute at the EBS University of Economics and Law. He went on to announce the delivery of the first results in the first quarter of 2012. “Incipient approaches toward a solution that have crystallised so far include the formation of a transparency culture, the development of internal stabilisation programmes, and the endorsement of a pro-active value added approach.”

Experts attribute the current situation to the low interest rate financing that was available in investment markets for many years. For instance, the major central banks boosted private consumption and investments in their respective national economies by keeping interest rates low, and facilitated the net debt of private households to soar as a result. Moreover, the bursting of the US real estate bubble in 2007 triggered a successive shift of private to public debt. “Many countries on the periphery of the European economy such as Greece, Portugal or Ireland proved unable to cover this debt load, thereby causing the sovereign debt crisis in the Eurozone. This has resulted in the fundamental restructuring of the global capital markets through regulatory measures such as Basel III, Solvency II or the Tobin tax currently under discussion that will impose higher capital requirements for financial institutions and insurance companies,” observes Rottke. “As a result, these institutions are forced to raise additional equity through asset sales, whereas governments are in turn trying to reduce their debt by selling assets. Distressed assets are the consequence of these trends, and they will shape the real estate investment environment for the foreseeable future.”

Distressed assets represent non-performing investments that have ceased to generate stable payments, or at a minimum, sufficient cash flow to support their capital structure. Most of them are marked by complex structures and low-levels of transparency, and involve both economic and legal risk exposure. This is true both for the commercial market, which shows a vast supply of distressed real estate and non-performing loans, and for Germany’s residential real estate market which was misjudged particularly by foreign investors. “Having initially overpaid as a result of missing market expertise, foreign investors erroneously assumed they would be able to successfully manage their real estate portfolios without a market presence of their own,” said Winter. “As a result, we are now seeing a large number of portfolios that are no longer able to service their debt under their own steam. Here, solutions will need to be identified to lay a new groundwork for economically sound real estate investments. This will also need to include a new approach for the communication between banks and investors that prevents the downgrading of performing debt to non-performing debt, and prevents values from being wiped out.”

That said, the majority of market participants do not have sufficient expertise in this area to fairly assess the risks and opportunities associated with it. This limits the circle of investors in both quantitative and qualitative terms. “Basically, only investors with local real estate knowledge, asset management expertise and the ability to restructure balance sheets have the right risk/return profile to successfully create economic value from such investments. This is where the wheat is separated from the chaff; where investors with a multi-value added strategy will make the difference, unlike those who deprive real estate of its value through a false management strategy,” emphasised Rottke who predicts attractive investment scenarios for the coming years due to the banks’ pressure on owners to sell.

“Real estate investments are subject to value creation processes. If this is disobeyed, performance suffers,” Winter added. “This makes it even more important to draw on the EBS research to shed light on the risks involved with the upcoming market situation in order to lay the basis for economically sound and sustainable real estate investments. Innovative solutions are needed to cope with the imminent financing freeze. To this end, we intend to collaborate with the Real Estate Management Institute of EBS University so as to make an active contribution and to develop models which will help turn non-performing portfolios back into real assets.”