DTZ Distressed Debt Report - November 2010

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The global commercial real estate debt gap as of November 2010 is $250bn globally, with the largest gap in Europe.


1. DTZ Insight Global Debt Funding Gap New equity to plug into messy workout24 November 2010 The debt funding gap continues to be the biggest challenge to many international property markets. The debt funding gap is the difference between the existing debt balance as it matures over time and the debt available to replace it. In this updated andContents expanded analysis, we incorporate loan maturity extensions.Introduction 2Global debt funding gap 3 Over the 2011-13 period, we estimate the global debt fundingNew equity sufficient to bridge gap 4 gap to total US$245bn. Europe has the greatest exposure (51%)Current market status 5 followed by Asia Pacific (29%) and the US (20%).Market outlook 7Appendix 9 Relative to their overall market size, many European markets, such as Ireland, Spain and the UK, have big debt funding gaps.Authors Japan is the only Asia Pacific market with a significant gap. In contrast, the US relative funding gap exposure is modest.Nigel AlmondForecasting & Strategy Research+44 (0)20 3296 2328 The global US$245bn debt funding gap can be bridged as therenigel.almond@dtz.com is US$376bn of equity capital available. But, there are regional differences, with Europe trailing (Figure 1).Konstantinos PapadopoulosForecasting & Strategy Research Currently, market participants and governments are going+44 (0)20 3296 2329 through a messy workout in a wide range of different solutions.kostis.papadopoulos@dtz.com Banks have moved on from pure extend and pretend to extend and amend - amending terms, such as margins and cash trapping. Banks are getting tougher on borrowers, but due toContacts swap breakage costs foreclosure is not always feasible.David Green-Morgan In future, we expect regulators and lenders to take cues from theHead of Asia Pacific Research US lending markets. The diversity of funding channels in the US+61 2 8243 9913 highlights the need for more non-bank lenders elsewhere.david.green-morgan@dtz.com Longer loan maturities, scheduled amortisation and fixedMagali Marton (unhedged) rates provide the US with significant advantages.Head of CEMEA Research+33 1 49 64 49 54 Figure 1.magali.marton@dtz.com Debt funding gap and available equity by region, 2011-2013 US$bn US$bnTony McGough 400 160 376Global Head of Forecasting & 145 350 140Strategy Research 126 300 116 115 120+44 (0)20 3296 2314 245tony.mcgough@dtz.com 250 100 200 70 80Hans Vrensen 150 49 60Global Head of Research 100 40+44 (0)20 3296 2159 50 20hans.vrensen@dtz.com 0 0 Global (LHS) Europe Asia Pacific US Available equity Debt funding gap Source: DTZ Research www.dtz.com 1 2. Global Debt Funding GapSection 1: Introduction Changes to methodologyThis report provides an update to our previous paper, the Since our previous report there have been a number of 1European Debt Funding Gap , which we published in changes which have necessitated revisions to ourMarch this year. We subsequently extended our analysis to approach in this report. Some of this reflects new 2009 2Asia Pacific in our Money into Property report . In the data for the UK, which was reported in De Montfortcurrent report we provide an update of our analysis and Universitys updated report on the UK lending market.extend it to include the United States. We have also made These key changes are outlined in Table 1. We discusssome refinements to our analysis to reflect market changes our methodology in more detail in the Appendix.and improvements to data. Table 1In this research we continue to define the debt funding gapas the gap between the existing debt balance and the debt Comparison of new data and original analytical inputsavailable to replace it. We consider the debt funding gap to New market March 2010be the biggest challenge to many international property Data data assumptionmarkets. It is a relevant issue because a lack of funding atmaturity is the most likely trigger of a loan event of default. Loan Two-thirds of loans maturing in No extensionsDefaults during the loan term have, and are expected to be, extensions 2009 were extendedlimited. Only at loan maturity is the borrower forced to find Extension 2009 extensions were 2.5 n/aan alternative refinancing source. maturities years on average Origination Actual LTV of 72% in 2009This is all the more important when we consider the 60% LTV was ahead of expectationsamount of outstanding debt to commercial real estateglobally, which we estimate to be US$6.8trillion. The Loan Year end 2009 figure (50bn) 17bn* originations above previous estimatesmajority of collateral is located in Europe and the US(Figure 2). Of this global debt, over a third (US$2.4 trillion) Capital Incorporate our latest Q3 2010is due to mature between 2011 and 2013. Many of these value n/a forecastsloans were originated or refinanced at the peak of the forecastsmarket in 2006/07. This presents a huge challenge to the Source: DTZ Research; De Montfort Universityindustry following significant falls in values and a tightening * Based on estimated debt available for refinancing only. New loans were excluded.in lending policies. It also comes at a time when manybanks are seeking to reduce their exposure to real estate, In our previous analysis, we did not make any explicitin response to regulatory changes like Basel III. assumptions on loan extensions due to the lack of relevant data. Market intelligence at the time suggested that loansFigure 2 were extended by a year or less. Recent data highlightsGlobal outstanding debt to commercial real estate, extensions averaging 2.5 years and in some cases up to 52009 years. In our updated methodology we have now explicitly accounted for the extension of loans in 2009 and assumed Rest of APAC it to continue into the foreseeable future. In this respect, Asia Pacific 24% Australia UK we assume a straight line reduction in loan maturity China Spain extensions from the two thirds in 2009 to fall to zero in Europe 2013. 38% Germany Japan The report is structured as follows. In the next section we France outline the debt funding gap globally. In section 3 we US$6.8trn compare this to the available equity. In section 4 we Rest of Europe discuss where the market is today, concluding in section 5 with our outlook for the market. US 38%Source: DTZ Research1 DTZ Insight, European Debt Funding Gap, 29 March 20102 Money into Property, Asia Pacific 2010, 11May 2010www.dtz.com 2 3. Global Debt Funding GapSection 2: Global debt funding gap Apart from Japan, the only other markets in the Asia Pacific region with any funding gap are Australia (US$0.5bn) and New Zealand (US$0.1bn).US$245bn global debt funding gap Notably, our research does not highlight any debt fundingOver the next three years (2011-2013) we estimate the gap in emerging markets such as China or India whichglobal debt funding gap to total US$245bn. In absolute have seen a development boom in recent years. Thisamounts, Europe has the largest debt funding gap of boom has been partly supported by debt. In fact, ChinaUS$126bn (51%). A further 29% (US$70bn) is in Asia has the second highest level of outstanding debt in thePacific with the remaining US$49bn (20%) in the US region after Japan. But, so far these markets have been(Figure 3). insulated from any significant downturn as capital values have held up.Figure 3Debt funding gap by region, 2011-2013 Ireland most exposed on a relative basis US$bn Total % 2011-13 Logically, those markets with high levels of outstanding 120 108 245 debt are likely to have high absolute debt funding gaps. This ignores the relative size of individual markets. 100 18 49 20% 81 Comparing the absolute debt funding gap relative to the 80 70 29% markets size (measured by its invested stock) shows the 19 30 56 relative exposures of individual markets (Figure 5). 60 12 23 40 Figure 5 18 126 51% 60 20 40 Debt funding gap as a percentage of invested stock 26 % Stock 0 2011 2012 2013 18% 16% Ireland Europe Asia Pacific US 14%Source: DTZ Research 12% 10% HungaryAmong individual countries the largest absolute debt 8%funding gap is in Japan (US$70bn), followed by the UK UK 6% New Zealand Spain(US$54bn), the US (US$49bn), and Spain (US$33bn). The Romania Switzerland Japanremaining markets, including Germany and France, have 4% Portugal Czech Rep Denmarkabsolute debt funding gaps below US$10bn (Figure 4). 2% Poland Italy Sweden Germany US France 0% AustraliaFigure 4 0 1 10 100Largest absolute funding gaps by country (2011-13) Absolute debt funding gap US$bn 2011-13 (log scale) Source: DTZ Research US$bn80 70 On this relative basis Ireland is the most exposed market70 with a debt funding gap over the next three years totalling60 54 US$6.5bn, equivalent to 16% of its invested stock. 4950 Hungary also has a high relative debt funding gap of 10%,40 despite having only a US$2bn absolute debt funding gap. 3330 Japan, Spain and the UK have high relative debt funding20 gaps each at 6% - as well as high absolute debt funding10 7 6 6 4 4 2 gaps. Despite having one of the highest absolute debt 0 funding gaps, on a relative basis the US is less exposed, as the debt funding gap represents just 1% of its invested stock. Both France and Germany also have low relative debt funding gaps at 1%.Source: DTZ Researchwww.dtz.com 3 4. Global Debt Funding GapUnsurprisingly the Asian markets of Australia and New In the rest of Asia, we see loan maturities of five years onZealand, which have low absolute debt funding gaps, are average. With more limited capital value falls, values arealso low on a relative basis. They sit alongside some other expected to have returned to the levels at the peak in 2007European countries, including the Czech Republic, Poland, by 2012. These variations explain the high debt fundingSweden and Switzerland. gap in Japan relative to the rest of Asia Pacific.Funding gap driven by loan maturity practices Section 3: New equity sufficient to bridge gap 3The differences in the debt funding gap between Based on our recently published research we estimateinternational markets is not a surprise when considering there to be US$376bn of equity available to be deployed inlending practices and capital value changes - factors which commercial real estate markets globally over 2011-13. Thisdrive the size of the debt funding gap. is more than 1.5 times the estimated debt funding gap of $245bn.In the US, loan maturities are on average ten years.Therefore any loans granted at the peak of the market in At a regional level we do see some differences. The2006/07 will not be due for refinance until 2016 at the amount of new equity targeting Europe (US$145bn) is onlyearliest. This provides some insulation to loans granted at just sufficient to cover the estimated debt funding gap ofthe peak from the large short term falls in capital values. US$126bn. In the other regions the amount of equity isThe majority of loans due for refinance in 2012 in the US, more than sufficient to cover the debt funding gap. In Asiawill have originated in 2002. By 2012 we estimate their Pacific the amount of available equity is more than 1.5value will be well above (25% higher) that at the point of times the debt funding gap, and 2.3 times greater in the USorigination (Table 2). Disregarding the further beneficial (Figure 6).impact of any scheduled amortisation, this timing explainsthe modest US debt funding gap. Figure 6 Debt funding gap and available equity, 2011-2013Table 2 US$bn US$bnCapital values index pre and post crisis 400 376 160 145 Year US Europe UK Japan Asia 350 140 Pacific 126 (ex UK) 300 116 115 120 (ex Japan) 245 250 1002002 56 56 74 48 39 200 70 802007 100 100 100 100 100 150 60 492010 64 81 75 57 95 100 402012 70 86 75 58 100 50 20Source: DTZ Research, IPD, MIT/NCREIF 0 0 Global (LHS) Europe Asia Pacific USIn contrast, we see a different picture in both Europe and Available equity Debt funding gapJapan. In continental Europe and the UK loan maturities Source: DTZ Researchare traditionally closer to five years. Here loans are moreexposed to the recent value declines. Loans originated in2007 will be secured by properties with values 14% lower Even when looking at the near term, in 2011, where wein 2012 across continental Europe. This is even greater in have greater clarity in the numbers, we do not see athe UK at 25%. These loan maturity and value trends problem, with the available equity (US$125bn) matchingreflect the variations in debt funding gaps across European the debt funding gap of (US$56bn) globally. A similarmarkets. picture emerges in each of the regions too. Of course, the short term extension of loans helps reduce the need forIn Japan, loans are traditionally for a period of three years, financing the debt funding gap in the near term.providing an even greater exposure. Loans maturing in2010 are expected to be backed by properties worth 43% But, it is not all positive news. As we highlighted in ourlower than at the peak in 2007. Also, we do not forecast previous study, many of these investors do not have theany significant appreciation in Japanese capital values by ability to buy loan or partial equity positions. Equally, loan2012. assets might not be priced to meet the required return 3 DTZ Insight: The Great Wall of Money, 13 October 2010www.dtz.com 4 5. Global Debt Funding Gapaspirations of the opportunity fund purchaser in many future uplift in values from a recovery in the markets andinstances. This is particularly the case on loans secured by from active management, rather than potentially having tosecondary properties, where relevant market evidence sell at distressed prices and crystallise any losses at anremains thin. Banks so far have not marketed loan early stage. On developments that have potential, banksportfolios backed by these types of properties. But, if are willing to enter into joint ventures with developers topricing is sufficiently attractive, we would expect sufficient see schemes through.investor interest. Inevitably, we are seeing more foreclosed assets comingMuch of the equity raised has the flexibility to be deployed to the market, notably the UK. In 2009 23 assets were soldin areas of greatest opportunity. Our research highlighted totalling 1.52bn. In the first three quarters of 2010, thethat 56% of the capital is targeted at multiple markets. number of sales by the administrators has already moreFurther, more than two thirds of that targeting single than doubled at 47, representing a further 0.87bn of sales.countries is focused on the US and UK -- both marketshave high absolute debt funding gaps. This flexibility In cases where all investors equity has been wiped outmeans investors can focus on opportunities in key markets. following adverse movements in capital values and high origination LTVs, borrowers lose interest in the property. InSection 4: Current market status a limited number of cases we have seen borrowers handing back the keys of the properties to the lender.Debt solutions come to the fore We also see an increase in the number of loan sales. Recently there have been a number of loan salesWe are seeing increased activity on the debt side. Having announced by banks seeking to reduce their real estateput their workout teams in place and reviewed their exposure.portfolios, banks are now starting to be proactive inbringing about solutions, especially on more problematic New entrants like debt funds are coming into the lendingloans. market, trying to exploit the gap that has been created by the subdued new debt issuance. Of course these are fewOne way is through consensual sales whereby the bank in number and would only deploy capital if pricing allowsforces a borrower to sell assets to meet their debt them to obtain the returns they seek. Table 3 belowobligations. Failure could result in the bank enforcing on summarises some of the solutions we have recently seenthe collateral. In some cases banks are teaming up with in the market, including new sources of finance.private equity players to actively manage foreclosedproperties. This enables the banks to share in the potential Table 3 Notable market deals Property/ Loan Parties involved Country Date Solution implemented Loan name amount Hammerson, GE Real Refinance of development loan with new 125 Old Broad Estate, Bank of Ireland/ UK 06/2010 135m Eurohypo replacing HSH Nordbank and Street Eurohypo Hypo Real Estate Foreclosed bank FDIC sells US commercial loans of failed FDIC US 07/2010 $1.85bn assets institutions Evans Randall/ Pramerica provided mezzanine debt from Drapers Gardens UK 09/2010 150m Pramerica its European debt platform Handed back keys to lender after equity Goldman Sachs Tiffany building Japan 09/2010 30bn was wiped out Targetfollow/ Placed into administration after failed Company loan UK 11/2010 700m Lloyds sales and new equity injection Centro managed In Consensual property sales to meet debt Centro Australia AUS$3.9bn funds properties progress repayment Propinvest/ AIB, In Consensual property sale to meet debt Citigroup tower UK 875m Santander, RBS progress repayment In RBS Spanish Loans Spain 1,7bn Seeking bids for sale of loan portfolio progress Source: DTZ Researchwww.dtz.com 5 6. Global Debt Funding GapExpected and necessary pressures still absent Governments have also taken stakes in banks to provide additional stability.Global property markets have been relatively slow inadjusting to the funding shortage. The fundamentals The only scheme in Europe with an active managementneeded to bridge the debt funding gap seem to exist and mandate is the National Asset Management Agencyequity is more than sufficient to fill the gap. However, (NAMA) in Ireland. The scope of the agency is to buy theactivity has been slow to pick up and the pressures to distressed loans from the countrys banks at a discount,inject new equity have largely failed to emerge. actively manage them and sell to maximise returns for the taxpayers. By September 2010 a total of 27bn of assetsThere remains a mismatch in pricing between potential had been transferred to NAMA. However, the agency willsellers and buyers. Sellers are not willing to sell at not hoard assets, nor will it engage in any fire sales. Wesignificant discounts to par while buyers are not willing to therefore see an orderly disposals process that is likely topay the full price, particularly for more secondary assets. start in 2011.Investors have managed to extend their commitment In the US, Congress created the Federal Depositperiods and the need to spend capital is not as urgent. On Insurance Corporation (FDIC) to insure the nationsthe borrowers side, the flexibility of banks on minor deposits and provide liquidity to ailing banks. Its purpose iscovenant breaches has not forced borrowers to find a to take over failed institutions and resolve them. This issolution to the gap, especially since most solutions would achieved usually by selling the deposits and loans of arequire giving up significant share of the collateral to a third failed institution to another institution. The FDIC has beenparty. As long as the cost of financing remains low, interest active since the 1930s and has been involved in a numberpayments are covered, and there are unlikely to be any of failed banks loan sales throughout all the turbulentsignificant covenant breaches, we do not foresee any periods since then. It has played a major role in the currentpressures for the banks to take action, thus transferring the crisis having sold loans with a total face value of $21bn,risk to the point of refinance. since May 2008.The expected removal of state supports which has In Asia Pacific support has been more limited, reflectingprovided banks with necessary liquidity have so far been the low debt funding gap. Nonetheless, the Bank of Japanslow to unwind. In fact, in the US, we have recently seen a has stated its willingness to support the J-REIT sector tosecond round of quantitative easing to provide support to provide confidence to the markets.the economy. In Europe, policy makers have not dismissedany further supports. Swap breakage costs additional barrier to enforcementThese policies have removed a significant amount ofpressure off of banks, allowing them to deal with a number However, a key restricting factor in enforcements is theof liquidity issues without engaging in any drastic solutions. widespread use of interest rate swaps on many EuropeanThe Basel III reserve requirements agreed in September loans. According to De Montfort Universitys bank lending2010 will ultimately lead to more conservative lending survey, 57% of the commercial real estate debtterms. As these will not take effect until the end of the outstanding in the UK has a swap agreement in place.decade, they are unlikely to significantly impact current Swaps were originally agreed to mitigate adverse interestpractice. rate movement risk. When a bank calls a loan in default, a swap breakage fee has to be paid.Although the pressures to bring equity and debt closer arenot there yet, more recently we have seen more Since the markets peaked interest rates have fallen bysophisticated solutions emerging. This indicates that approximately 350bps in Europe, 450bps in the US and bybanks and borrowers are becoming more willing to find 550bps in the UK. Given the steepness of this decrease inways to bridge the gap. interest rates and the long duration of most of those swaps, the breakage cost can be significant.Different state approaches amongst the regions This has prevented banks from taking necessary action toWe have also seen significant differences in the way mid-term nonperforming loans given the extra cost burden.different regions have approached the debt funding gap. In In some cases the breakage costs can be as high as 20%Europe, we have seen a number of government and of the loan amount. On the other hand, holding on to largecentral bank support schemes, usually funded by property portfolios is limiting their appetite and capacity totaxpayers. The majority of these mainly act as insurance in lend in commercial real estate and holds the market to athe case of losses, to prevent further liquidity shortages. stall.www.dtz.com 6 7. Global Debt Funding GapMoving from extend and pretend to extend and A factor that has placed the US in a relatively betteramend position than Europe is the diversity in funding. Lending is traditionally split between banking institutions, otherIn 2008 when the problems of refinancing loans first lenders including life insurance companies and CMBS. Inemerged, banks would often roll-over these loans for a contrast, around three quarters of the European market isperiod of a year. But as the financial crisis continued and dominated by banks, with the remaining quarter splitfunding channels for banks remained restricted we have between covered bonds and CMBS. In Asia Pacific lendingseen the continued process of extending loans for an is dominated by banks.average of two and a half years. This diversity is helping the US in their way out of theRecently, we have seen a move from the extension of funding shortage, where we see the beginnings of newloans to a combined extension and amendment of the issuances of CMBS. Although it is nowhere near the levelsbase loan terms and covenants. In some cases the seen over recent years, it is nonetheless an indication offinance has been provided by the existing lender, but in a life returning to the market, which should support newgrowing number of refinancing cases we have seen new funding (Figure 8).parties come to the fold, in particular German lenders whohave support of the Pfandbrief market. Figure 8 New CMBS issuance, 2008-YTD 2010Banks are also enforcing full cash trapping. This can affecta borrowers liquidity position significantly as any excess US$bnrevenues from a secured property has to be used for the 14amortisation of the loan. 12But, given that in many regions, values are not expected to 10recover until beyond 2012, we believe the extend and 8pretend model is not sustainable in the long run. 6Section 5: Market outlook 4 2Need for more non-bank lenders 0 US Europe Asia PacificRegionally we see differences in the structure of lending 2008 2009 YTD 2010markets which has implications for the availability of debt Source: Bank of America Merrill Lynch, CREFCthrough different funding channels (Figure 7).Figure 7 In Europe new CMBS issuance has not shown the long waited signs of revival yet. Here differences in the structureOutstanding commercial real estate debt by lender of loans is delaying any recovery. The issuance that wetype, 2009 have seen has been restricted to just a handful of deals where the underlying tenant covenant has been the driver100% 2% 4% rather than the asset. 90% 18% 18% 80% 6% Still the prospects for a real recovery in Europe remain thin. 70% Here, the only alternative to bank lending is through the 24% 60% covered bond market which accounts for 18% of current 50% 96% outstanding debt (Figure 7). However, this is heavily 40% 76% dominated by the German Pfandbrief market, which is the 30% 55% only real source of new lending and refinance in the 20% current market. In its absence, European lending markets 10% would be in an even more perilous position. 0% US Europe Asia Pacific Lending terms provide immunity Banks CMBS Insurance cos & other institutions Covered bonds Further differences among the regions relate to lendingSource: DTZ Research practice and loan terms. These can provide some immunitywww.dtz.com 7 8. Global Debt Funding Gapto the debt funding gap in some cases, or restrict solutions Banks have committed to restructure and reduce exposurein others. in the property sector within a particular timescale. We therefore expect to see more activity from banks to bringAs we highlighted in section 2, loan length is of great about solutions going forward in an orderly fashion. Everyimportance. Longer maturities can protect from the short case is likely to be treated individually. Discussionsterm volatility in capital values. As property tends to be between borrowers and banks should begin at the earlycyclical it is likely that values revert to their mean in the stages of the refinancing requirements as trust is essentiallong run. The US tends to have longer loan maturities that to an effective and fair solution between the two parties.have so far been insulated against the recent falls invalues. Although this cannot provide a solution to the Secondary assets most exposedcurrent debt funding gap, we might see the adoption ofsuch practice in European and Asia Pacific markets in the The quality of the collateral is also of significant importance,future, especially as regulatory pressures increase. with secondary properties likely facing a much higher refinancing risk than the prime ones. This reflects the factThe high cost of breaking swap contracts has proved to be that values on secondary assets have been more exposeda significant liquidity barrier. Contracts which are longer in in the current downturn. Peak to trough in the UK, valueslength than the underlying loan are most at risk. But these on secondary assets have fallen more than on prime.are likely to diminish as the swap breakage cost is directly Added to this the value of secondary assets have notlinked to the outstanding length to maturity. An alternative recovered as much as prime, leaving these assets moresolution could be an increased use of fixed rate loans. exposed. Given the risk aversion in the markets, investors are seeking only prime properties with demand forAnother way to protect against a future debt funding gap is secondary ones remaining very thin. This is clearly evidentthe increased use of fully amortising loans. By amortizing when comparing the upper and lower quartile yieldthe principal during the loan term, the outstanding balance movement on the IPD UK index. This also indicates thatreduces as loans get closer to maturity, reducing the investors are more likely to enter loan positions backed uprefinance risk. Again such practices are more prevalent in by better quality assets rather than riskier ones.the US. Figure 9Regulatory changes to affect decisions UK prime v secondary yield movementAlthough banks and borrowers have not been forced to %engage in more dramatic solutions, potential changes 14might affect their decisions in the short term. Those 12changes relate to both the equity and the debt side: 10 As governments focus more and more on their 8 sovereign deficits and debt, a potential unwinding of 6 accommodation policies will put weight on banks to 4 deal with their most problematic loan positions. 2 Although the Basel III reserve requirements do not kick 0 in until the end of the decade, they will impose stricter capital requirements. These also include new regulations that will discourage banks from securing Prime/secondary spread All Property Prime Equivalent Yield All Property Secondary Equivalent Yield funding from the CMBS markets, while encouraging them to access the covered bond markets. Source: IPD, DTZ Research Further regulatory reforms, including Solvency II, new For a borrower, a larger fall in value means there is a rating rules, the EU Alternative Investment Fund greater chance of the equity being wiped out. In such managers Directive, the Dodd-Frank reform and instances they are unlikely to be willing to put in any capital Consumer Protection Act present further challenges in expenditure leading to a possible further deterioration in the years to come. the asset and possibly the income stream. In such cases banks will be less willing to refinance placing greater Interest rates are currently at record low levels. Any pressure on the borrower to plug the gap or face increase will deteriorate the position of the more foreclosure. struggling borrowers and force them to find a solution.www.dtz.com 8 9. Global Debt Funding GapAppendix: Revised methodology Step 1: Calculate outstanding commercial real estate debt by origination vintageOur approach to estimating the debt funding gap is broadlyunchanged on our last report. In Figure 10 we highlight the Our starting point has been to take data for the UK usingsix key steps to estimating the debt funding gap based on De Montfort Universitys (DMU) lending survey. From theone single loan. data we know the originations (in bank lending and CMBS) for each year, and from these we deduct what has maturedFigure 10 before 2010. For the purpose of this analysis we are only interested in the sum of originations which equate to theEstimating the debt funding gap outstanding amount as at end 2009 (Figure 11). US$m120 Figure 11 b100 Loan origination profile d bn 80 g 298 e 300 60 17% a 250 40 14% f 200 20 26% 0 150 2006 Loan Fall in value Asset value Debt available Funding gap 2006-11 2011 2011 100 26% c 50Source: DTZ Research 16% 0In the above example we calculate the gap for a single x 2009 2008 2007 2006 2005loan in the UK as follows: Source: De Montfort University; DTZ Research a) Loan of 100m granted in 2006. b) Value of assets financed total 116m, assuming Compared with our previous study the proportion of loans an LTV of 86% in 2006. originated in 2009 was higher than we previously c) Loan due to mature in 2011 (five year term). estimated (17%), compared to our previous estimate (6%). 4 With a higher proportion, and hence value, of loans d) Based on capital value changes from the IPD index and our forecasts, we estimate that values originating in 2009, our analysis now goes back to 2005, will have fallen by 32% (37m) over 2006-2011. rather than 2004. e) The resulting asset value at 2011 is 79m. f) In 2011 we estimate that debt of 58m will be We assume that the origination of European and Asian available for refinance based on a 73% LTV. loans follows the same pattern as the DMU data, and apply g) The debt funding gap of 42m is the difference these proportions to the total outstanding debt secured between the value of the original loan (100m) and against properties in each country taken from our Money the estimated debt available for refinance (58m). into Property database, including the UK for consistency, as at the end of 2009. In this way, we look at the debtIn reality we are dealing with a multitude of loans, underlying the properties in each market, rather than theoriginated in different years and of differing maturities. In country in which the loans were originated.contrast to our previous paper, we also need to account fora proportion of loans to be extended. The following For example, 26% of the outstanding debt in the UKdescribes in more detail how we reached our numbers originated from 2006. We therefore assume 26% of debtbased on the above process, step-by-step. Please note originated in this year, in each country. In this way thesome of the charts relate to a specific country. sum of the originations equals the current outstanding debt. In the US, we have estimated the loan originations each year by applying the loan origination profile from the Mortgage Bankers Association to total loans outstanding in the US as at the end of 2009. As maturities in the US are4 We ignore any impacts from depreciation in our analysis.www.dtz.com 9 10. Global Debt Funding Gaptraditionally longer, averaging around 10 years, we have Figure 13extended the period we cover in the US to 2001. This waywe capture the majority of maturities over the forecast Maturity profile of loans by origination vintageperiod. US$bn 100Step 2: Estimate refinancing requirements by origination 90 2012vintage 80 2011 2010 70The next step is to calculate the refinancing requirements 2009 60using the loan originations calculated in step 1. The DMU 2008 50study provides data on the duration of loans by origination 40vintage in the UK up to 2009. In order to complete the 2007analysis to 2013, we have made assumptions on the loan 30duration of loans in 2010-2012 (Figure 12). 20 2006 10 2005Figure 12 0 2011 2012 2013Loan duration by origination vintage Source: DTZ Research 18% 16% 2008, 2009 prev. As outlined in section 1, we also know that some loans are 14% being extended at maturity for an average of two and a half 12% years and varying in length between one and five years. 2010, 2011, 2012 The value of these loans needs to be pushed into future 10% maturities in order to estimate the amount of debt available. 8% 6% We have assumed that 50% of loans extended are for a 2005, 2006, 2007, 2009 period of two years, 20% for three years and 10% each for 4% 2011, 2012 prev. a period of one, four and five years. This gives an average 2% extension of two and a half years. In 2009 we know two- 0% thirds of loans were extended. We assume a gradual 1-y 2-y 3-y 4-y 5-y 6-y 7-y 8-y 9-y 10-y reduction in the proportion of extensions to zero in 2013 onSource: De Montfort University; DTZ Research a straight line basis (Figure 14).With full data now available for 2009, we can see that the Figure 14profile of durations in 2009 differs from what we previously Profile of loan extensionsassumed, i.e. rather than having a higher proportion ofshorter term loans, the profile is actually closer to that seen 100% 60%in the peak of the market. 90% 50% 80%As a result, we have also adjusted our future loan 70% 40%durations to more closely align with what we have seen 60%historically, rather than the gradual adjustment to this trend 50% 30%in our previous analysis. Applying these loan durations to 40% 50%the loan originations we create the future maturity profile 30% 67% 20%(Figure 13). 50% 20% 33% 20% 10% 10% 17% 10% 10% 10%We assume the same profile for CMBS and for loans 0% 0%across Europe and Asia Pacific. In the US we have used 2009 2010 2011 2012 2013 1-y 2-y 3-y 4-y 5-ydata on CMBS loans from Bloomberg to create a loanduration series to 2006. For future years we have assumed Loans extended Loans matured Extension profile (RHS)the same profile as for 2006. Source: De Montfort University, DTZ Research Allowing for extensions, we see an adjustment to the maturity profile. This is best shown by taking the examplewww.dtz.com 10 11. Global Debt Funding Gapof the single loan we highlighted at the start of this report. Step 3: Estimate original property values by originationIn this example, the first four steps of the process remain vintagethe same (Figure 15). Thereafter we see some smallchanges. Based on historic maximum loan to value ratios (LTVs) at the all property level from the DMU survey, we can e) By extending the loan by a period of two years calculate the value of the underlying assets in each year from 2011 to 2013, we benefit from a further uplift (Figure 17). We have assumed LTVs are similar in most in capital values. markets in Europe and made assumptions from local f) In this case values improve by 3% to 82m. offices for markets in the Asia Pacific region. In the US, we g) With a marginally higher LTV of 75% we can have made adjustments from CMBS loan data from borrow more (61m). Bloomberg. h) The resulting debt funding gap is marginally lower (-7%) at 39m. Figure 17Figure 15 Original property values by origination vintage US$bn LTV %Estimating the debt funding gap with extensions 200 100% 180 84% 87% 86% 84% 90% US$m120 160 72% 72% 73% 74% 75% 80% b d 140 75% 75% 70%100 120 70% 60% 65% e 100 60% 50% 80 h 80 40% 60 30% 60 40 20% a f 20 10% 40 g 0 0% 20 2005 2006 2007 2008 2009 2010 2011 2012 2013 0 Loan origination Implied equity 2006 Loan Fall in value Asset value Debt Funding gap Max LTV (RHS) Max LTV (March report) (RHS) 2006-11 2013 available 2013 Source: DTZ Research 2013 cSource: DTZ Research Step 4: Estimate future property value to be refinancedThe resulting maturity profile is outlined in Figure 16 and Applying capital value changes to each of the assetsclearly shows the shift in maturity to later years. underlying the loans by vintage and the known maturity profiles we can calculate the future value of the underlyingFigure 16 assets. For the UK we have applied capital value changes from IPD as this provides a better proxy for the market as aMaturity profile before and after extensions whole. In continental Europe and Asia Pacific, IPDsUS$bn coverage and history is not as extensive, therefore we120 have derived an All Property series based on our own 2012 prime capital values for each country. For both series we100 apply our own forecasts, which provide us with the value of 2011 2010 assets to be refinanced in future years. 80 2009 60 2008 In the US we have used a capital value series from the MIT/ NCREIF transaction index, which provides a better 2007 proxy for the overall market. To this we have applied our 40 own forecasts for prime capital values going forward. 20 2006 2005 0 Before After Before After Before After extensions extensions extensions extensions extensions extensions 2011 2012 2013Source: DTZ Researchwww.dtz.com 11 12. Global Debt Funding GapStep 5: Estimate available debt for future refinancing Step 6: Calculate funding gap between existing debtbased on future LTVs refinancing requirements and debt availableTaking the value of assets for refinance (step 4), and The final step is to calculate the debt funding gap. We doapplying our estimates for LTVs, we can calculate the this for each individual year by deducting the value of debtvalue of debt that we estimate to be available (Figure 18). available (step 5) from the value of loans for refinance inIn our previous research we assumed that LTVs had fallen each year (step 2). The sum of all the positive valuesto 60% in 2009. From the 2009 DMU survey we know the leaves the total value of equity required the debt fundingaverage LTV was in fact higher at 72%. In future years we gap (Figure 19). In this analysis we have used the yearshave assumed a gradual recovery to 75% in Europe and 2011-2013 to provide a forward looking view, even thoughthe US. In Asia Pacific we assume a recovery to 70%. 2010 is a forecast year in our analysis.Figure 18 Figure 19Estimating the value of debt available in the UK UK debt funding gap US$bn LTV US$bn120 112 76% 120100 92 100 24 84 75% 80 80 67 68 18 60 74% 60 49 12 107 40 40 87 84 73% 68 61 20 49 20 0 72% 0 2011 2012 2013 2011 2011 20122012 20132013 Value of assets for refinance Debt available max % refinancing LTV (RHS) Refinancing requirements (Step 2) Debt available Debt funding gapSource: DTZ Research Source: DTZ Researchwww.dtz.com 12 13. Disclaimer This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. 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