dtz distressed debt report

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DTZ Insight Global Debt Funding Gap

New equity to plug into messy workout

24 November 2010

Contents Introduction 2 Global debt funding gap 3 New equity sufficient to bridge gap 4 Current market status 5 Market outlook 7 Appendix 9

Authors Nigel Almond Forecasting & Strategy Research +44 (0)20 3296 2328 [email protected] Konstantinos Papadopoulos Forecasting & Strategy Research +44 (0)20 3296 2329 [email protected]

Contacts David Green-Morgan Head of Asia Pacific Research +61 2 8243 9913 [email protected] Magali Marton Head of CEMEA Research +33 1 49 64 49 54 [email protected] Tony McGough Global Head of Forecasting & Strategy Research +44 (0)20 3296 2314 [email protected] Hans Vrensen Global Head of Research +44 (0)20 3296 2159 [email protected]

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 and expanded analysis, we incorporate loan maturity extensions.

Over the 2011-13 period, we estimate the global debt funding gap to total US$245bn. Europe has the greatest exposure (51%) followed by Asia Pacific (29%) and the US (20%).

Relative to their overall market size, many European markets, such as Ireland, Spain and the UK, have big debt funding gaps. Japan is the only Asia Pacific market with a significant gap. In contrast, the US relative funding gap exposure is modest.

The global US$245bn debt funding gap can be bridged as there is US$376bn of equity capital available. But, there are regional differences, with Europe trailing (Figure 1).

Currently, market participants and governments are going through a messy workout in a wide range of different solutions. 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 to swap breakage costs foreclosure is not always feasible.

In future, we expect regulators and lenders to take cues from the US lending markets. The diversity of funding channels in the US highlights the need for more non-bank lenders elsewhere. Longer loan maturities, scheduled amortisation and fixed (unhedged) rates provide the US with significant advantages.

Figure 1.

Debt funding gap and available equity by region, 2011-2013

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Available equity Debt funding gap Source: DTZ Research

Global Debt Funding Gap

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Section 1: Introduction

This report provides an update to our previous paper, the European Debt Funding Gap

1, which we published in

March this year. We subsequently extended our analysis to Asia Pacific in our Money into Property report

2. In the

current report we provide an update of our analysis and extend it to include the United States. We have also made some refinements to our analysis to reflect market changes and improvements to data. In this research we continue to define the debt funding gap as the gap between the existing debt balance and the debt available to replace it. We consider the debt funding gap to be the biggest challenge to many international property markets. It is a relevant issue because a lack of funding at maturity is the most likely trigger of a loan event of default. Defaults during the loan term have, and are expected to be, limited. Only at loan maturity is the borrower forced to find an alternative refinancing source. This is all the more important when we consider the amount of outstanding debt to commercial real estate globally, which we estimate to be US$6.8trillion. The majority of collateral is located in Europe and the US (Figure 2). Of this global debt, over a third (US$2.4 trillion) is due to mature between 2011 and 2013. Many of these loans were originated or refinanced at the peak of the market in 2006/07. This presents a huge challenge to the industry following significant falls in values and a tightening in lending policies. It also comes at a time when many banks are seeking to reduce their exposure to real estate, in response to regulatory changes like Basel III.

Figure 2

Global outstanding debt to commercial real estate, 2009

UK

Spain

Germany

France

Rest of Europe

US38%

Japan

China

Australia

Rest of APAC

Europe38%

Asia Pacific24%

US$6.8trn

Source: DTZ Research

1 DTZ Insight, European Debt Funding Gap, 29 March 2010

2 Money into Property, Asia Pacific 2010, 11May 2010

Changes to methodology

Since our previous report there have been a number of changes which have necessitated revisions to our approach in this report. Some of this reflects new 2009 data for the UK, which was reported in De Montfort University’s updated report on the UK lending market. These key changes are outlined in Table 1. We discuss our methodology in more detail in the Appendix.

Table 1

Comparison of new data and original analytical inputs

Data New market

data

March 2010 assumption

Loan extensions

Two-thirds of loans maturing in 2009 were extended

No extensions

Extension maturities

2009 extensions were 2.5 years on average

n/a

Origination LTV

Actual LTV of 72% in 2009 was ahead of expectations

60%

Loan originations

Year end 2009 figure (£50bn) above previous estimates

£17bn*

Capital value forecasts

Incorporate our latest Q3 2010 forecasts

n/a

Source: DTZ Research; De Montfort University

* Based on estimated debt available for refinancing only. New loans were excluded.

In our previous analysis, we did not make any explicit assumptions on loan extensions due to the lack of relevant data. Market intelligence at the time suggested that loans were extended by a year or less. Recent data highlights extensions averaging 2.5 years and in some cases up to 5 years. In our updated methodology we have now explicitly accounted for the extension of loans in 2009 and assumed it to continue into the foreseeable future. In this respect, we assume a straight line reduction in loan maturity extensions from the two thirds in 2009 to fall to zero in 2013. The report is structured as follows. In the next section we outline the debt funding gap globally. In section 3 we compare this to the available equity. In section 4 we discuss where the market is today, concluding in section 5 with our outlook for the market.


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Section 2: Global debt funding gap

US$245bn global debt funding gap Over the next three years (2011-2013) we estimate the global debt funding gap to total US$245bn. In absolute amounts, Europe has the largest debt funding gap of US$126bn (51%). A further 29% (US$70bn) is in Asia Pacific with the remaining US$49bn (20%) in the US (Figure 3).

Figure 3

Debt funding gap by region, 2011-2013

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6018

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2011 2012 2013

US$bn

Europe Asia Pacific US

56

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126 51%

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49 20%

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Total2011-13

%


Among individual countries the largest absolute debt funding gap is in Japan (US$70bn), followed by the UK (US$54bn), the US (US$49bn), and Spain (US$33bn). The remaining markets, including Germany and France, have absolute debt funding gaps below US$10bn (Figure 4).

Figure 4

Largest absolute funding gaps by country (2011-13)

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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). Notably, our research does not highlight any debt funding gap in emerging markets such as China or India which have seen a development boom in recent years. This boom has been partly supported by debt. In fact, China has the second highest level of outstanding debt in the region after Japan. But, so far these markets have been insulated from any significant downturn as capital values have held up.

Ireland most exposed on a relative basis Logically, those markets with high levels of outstanding debt are likely to have high absolute debt funding gaps. This ignores the relative size of individual markets. Comparing the absolute debt funding gap relative to the market’s size (measured by its invested stock) shows the relative exposures of individual markets (Figure 5).

Figure 5

Debt funding gap as a percentage of invested stock

Czech Rep Denmark

France Germany

Hungary

Ireland

ItalyPoland

Portugal

RomaniaSpain

Sweden

Switzerland

UK

Australia

Japan

New Zealand

US

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% Stock

Absolute debt funding gap US$bn 2011-13 (log scale) Source: DTZ Research

On this relative basis Ireland is the most exposed market with a debt funding gap over the next three years totalling US$6.5bn, equivalent to 16% of its invested stock. Hungary also has a high relative debt funding gap of 10%, despite having only a US$2bn absolute debt funding gap. Japan, Spain and the UK have high relative debt funding gaps – each at 6% - as well as high absolute debt funding gaps. Despite having one of the highest absolute debt 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%.


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Unsurprisingly the Asian markets of Australia and New Zealand, which have low absolute debt funding gaps, are also low on a relative basis. They sit alongside some other European countries, including the Czech Republic, Poland, Sweden and Switzerland.

Funding gap driven by loan maturity practices The differences in the debt funding gap between international markets is not a surprise when considering lending practices and capital value changes - factors which drive the size of the debt funding gap. In the US, loan maturities are on average ten years. Therefore any loans granted at the peak of the market in 2006/07 will not be due for refinance until 2016 at the earliest. This provides some insulation to loans granted at the peak from the large short term falls in capital values. The majority of loans due for refinance in 2012 in the US, will have originated in 2002. By 2012 we estimate their value will be well above (25% higher) that at the point of origination (Table 2). Disregarding the further beneficial impact of any scheduled amortisation, this timing explains the modest US debt funding gap.

Table 2

Capital values index pre and post crisis

Year US Europe

(ex UK)

UK Japan Asia Pacific

(ex Japan)

2002 56 56 74 48 39

2007 100 100 100 100 100

2010 64 81 75 57 95

2012 70 86 75 58 100

Source: DTZ Research, IPD, MIT/NCREIF

In contrast, we see a different picture in both Europe and Japan. In continental Europe and the UK loan maturities are traditionally closer to five years. Here loans are more exposed to the recent value declines. Loans originated in 2007 will be secured by properties with values 14% lower in 2012 across continental Europe. This is even greater in the UK at 25%. These loan maturity and value trends reflect the variations in debt funding gaps across European markets. In Japan, loans are traditionally for a period of three years, providing an even greater exposure. Loans maturing in 2010 are expected to be backed by properties worth 43% lower than at the peak in 2007. Also, we do not forecast any significant appreciation in Japanese capital values by 2012.

In the rest of Asia, we see loan maturities of five years on average. With more limited capital value falls, values are expected to have returned to the levels at the peak in 2007 by 2012. These variations explain the high debt funding gap in Japan relative to the rest of Asia Pacific.

Section 3: New equity sufficient to bridge gap Based on our recently published research

3 we estimate

there to be US$376bn of equity available to be deployed in commercial real estate markets globally over 2011-13. This is more than 1.5 times the estimated debt funding gap of $245bn. At a regional level we do see some differences. The amount of new equity targeting Europe (US$145bn) is only just sufficient to cover the estimated debt funding gap of US$126bn. In the other regions the amount of equity is more than sufficient to cover the debt funding gap. In Asia Pacific the amount of available equity is more than 1.5 times the debt funding gap, and 2.3 times greater in the US (Figure 6).

Figure 6

Debt funding gap and available equity, 2011-2013

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Available equity Debt funding gap Source: DTZ Research

Even when looking at the near term, in 2011, where we have greater clarity in the numbers, we do not see a problem, with the available equity (US$125bn) matching the debt funding gap of (US$56bn) globally. A similar picture emerges in each of the regions too. Of course, the short term extension of loans helps reduce the need for financing the debt funding gap in the near term. But, it is not all positive news. As we highlighted in our previous study, many of these investors do not have the ability to buy loan or partial equity positions. Equally, loan assets might not be priced to meet the required return

3 DTZ Insight: The Great Wall of Money, 13 October 2010


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aspirations of the opportunity fund purchaser in many instances. This is particularly the case on loans secured by secondary properties, where relevant market evidence remains thin. Banks so far have not marketed loan portfolios backed by these types of properties. But, if pricing is sufficiently attractive, we would expect sufficient investor interest. Much of the equity raised has the flexibility to be deployed in areas of greatest opportunity. Our research highlighted that 56% of the capital is targeted at multiple markets. Further, more than two thirds of that targeting single countries is focused on the US and UK -- both markets have high absolute debt funding gaps. This flexibility means investors can focus on opportunities in key markets.

Section 4: Current market status Debt solutions come to the fore We are seeing increased activity on the debt side. Having put their workout teams in place and reviewed their portfolios, banks are now starting to be proactive in bringing about solutions, especially on more problematic loans. One way is through consensual sales whereby the bank forces a borrower to sell assets to meet their debt obligations. Failure could result in the bank enforcing on the collateral. In some cases banks are teaming up with private equity players to actively manage foreclosed properties. This enables the banks to share in the potential

future uplift in values from a recovery in the markets and from active management, rather than potentially having to sell at distressed prices and crystallise any losses at an early stage. On developments that have potential, banks are willing to enter into joint ventures with developers to see schemes through. Inevitably, we are seeing more foreclosed assets coming to the market, notably the UK. In 2009 23 assets were sold totalling £1.52bn. In the first three quarters of 2010, the number of sales by the administrators has already more than doubled at 47, representing a further £0.87bn of sales. In cases where all investors’ equity has been wiped out following adverse movements in capital values and high origination LTVs, borrowers lose interest in the property. In a limited number of cases we have seen borrowers handing back the keys of the properties to the lender. We also see an increase in the number of loan sales. Recently there have been a number of loan sales announced by banks seeking to reduce their real estate exposure. New entrants like debt funds are coming into the lending market, trying to exploit the gap that has been created by the subdued new debt issuance. Of course these are few in number and would only deploy capital if pricing allows them to obtain the returns they seek. Table 3 below summarises some of the solutions we have recently seen in the market, including new sources of finance.

Table 3

Notable market deals

Parties involved Property/ Loan name

Country Date Loan amount

Solution implemented

Hammerson, GE Real Estate, Bank of Ireland/ Eurohypo

125 Old Broad Street

UK 06/2010 £135m Refinance of development loan with new Eurohypo replacing HSH Nordbank and Hypo Real Estate

FDIC Foreclosed bank assets

US 07/2010 $1.85bn FDIC sells US commercial loans of failed institutions

Evans Randall/ Pramerica

Draper’s Gardens UK 09/2010 £150m Pramerica provided mezzanine debt from its European debt platform

Goldman Sachs Tiffany building Japan 09/2010 ¥30bn Handed back keys to lender after equity was wiped out

Targetfollow/ Lloyds

Company loan UK 11/2010 £700m Placed into administration after failed sales and new equity injection

Centro Centro managed funds properties

Australia In progress

AUS$3.9bn Consensual property sales to meet debt repayment

Propinvest/ AIB, Santander, RBS

Citigroup tower UK In progress

£875m Consensual property sale to meet debt repayment

RBS Spanish Loans Spain In progress

£1,7bn Seeking bids for sale of loan portfolio



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Expected and necessary pressures still absent Global property markets have been relatively slow in adjusting to the funding shortage. The fundamentals needed to bridge the debt funding gap seem to exist and equity is more than sufficient to fill the gap. However, activity has been slow to pick up and the pressures to inject new equity have largely failed to emerge. There remains a mismatch in pricing between potential sellers and buyers. Sellers are not willing to sell at significant discounts to par while buyers are not willing to pay the full price, particularly for more secondary assets. Investors have managed to extend their commitment periods and the need to spend capital is not as urgent. On the borrowers’ side, the flexibility of banks on minor covenant breaches has not forced borrowers to find a solution to the gap, especially since most solutions would require giving up significant share of the collateral to a third party. As long as the cost of financing remains low, interest payments are covered, and there are unlikely to be any significant covenant breaches, we do not foresee any pressures for the banks to take action, thus transferring the risk to the point of refinance. The expected removal of state supports which has provided banks with necessary liquidity have so far been slow to unwind. In fact, in the US, we have recently seen a second round of quantitative easing to provide support to the economy. In Europe, policy makers have not dismissed any further supports. These policies have removed a significant amount of pressure off of banks, allowing them to deal with a number of liquidity issues without engaging in any drastic solutions. The Basel III reserve requirements agreed in September 2010 will ultimately lead to more conservative lending terms. As these will not take effect until the end of the decade, they are unlikely to significantly impact current practice. Although the pressures to bring equity and debt closer are not there yet, more recently we have seen more sophisticated solutions emerging. This indicates that banks and borrowers are becoming more willing to find ways to bridge the gap.

Different state approaches amongst the regions

We have also seen significant differences in the way different regions have approached the debt funding gap. In Europe, we have seen a number of government and central bank support schemes, usually funded by taxpayers. The majority of these mainly act as insurance in the case of losses, to prevent further liquidity shortages.

Governments have also taken stakes in banks to provide additional stability. The only scheme in Europe with an active management mandate is the National Asset Management Agency (NAMA) in Ireland. The scope of the agency is to buy the distressed loans from the country’s banks at a discount, actively manage them and sell to maximise returns for the taxpayers. By September 2010 a total of €27bn of assets had been transferred to NAMA. However, the agency will not hoard assets, nor will it engage in any fire sales. We therefore see an orderly disposals process that is likely to start in 2011. In the US, Congress created the Federal Deposit Insurance Corporation (FDIC) to insure the nation’s deposits and provide liquidity to ailing banks. Its purpose is to take over failed institutions and resolve them. This is achieved usually by selling the deposits and loans of a failed institution to another institution. The FDIC has been active since the 1930’s and has been involved in a number of failed banks loan sales throughout all the turbulent periods since then. It has played a major role in the current crisis having sold loans with a total face value of $21bn, since May 2008. In Asia Pacific support has been more limited, reflecting the low debt funding gap. Nonetheless, the Bank of Japan has stated its willingness to support the J-REIT sector to provide confidence to the markets.

Swap breakage costs additional barrier to enforcement However, a key restricting factor in enforcements is the widespread use of interest rate swaps on many European loans. According to De Montfort University’s bank lending survey, 57% of the commercial real estate debt outstanding in the UK has a swap agreement in place. Swaps were originally agreed to mitigate adverse interest rate movement risk. When a bank calls a loan in default, a swap breakage fee has to be paid. Since the markets peaked interest rates have fallen by approximately 350bps in Europe, 450bps in the US and by 550bps in the UK. Given the steepness of this decrease in interest rates and the long duration of most of those swaps, the breakage cost can be significant. This has prevented banks from taking necessary action to mid-term nonperforming loans given the extra cost burden. In some cases the breakage costs can be as high as 20% of the loan amount. On the other hand, holding on to large property portfolios is limiting their appetite and capacity to lend in commercial real estate and holds the market to a stall.


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Moving from extend and pretend to extend and amend In 2008 when the problems of refinancing loans first emerged, banks would often roll-over these loans for a period of a year. But as the financial crisis continued and funding channels for banks remained restricted we have seen the continued process of extending loans for an average of two and a half years. Recently, we have seen a move from the extension of loans to a combined extension and amendment of the base loan terms and covenants. In some cases the finance has been provided by the existing lender, but in a growing number of refinancing cases we have seen new parties come to the fold, in particular German lenders who have support of the Pfandbrief market. Banks are also enforcing full cash trapping. This can affect a borrowers’ liquidity position significantly as any excess revenues from a secured property has to be used for the amortisation of the loan. But, given that in many regions, values are not expected to recover until beyond 2012, we believe the extend and pretend model is not sustainable in the long run.

Section 5: Market outlook Need for more non-bank lenders Regionally we see differences in the structure of lending markets which has implications for the availability of debt through different funding channels (Figure 7).

Figure 7

Outstanding commercial real estate debt by lender type, 2009

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A factor that has placed the US in a relatively better position than Europe is the diversity in funding. Lending is traditionally split between banking institutions, other lenders including life insurance companies and CMBS. In contrast, around three quarters of the European market is dominated by banks, with the remaining quarter split between covered bonds and CMBS. In Asia Pacific lending is dominated by banks. This diversity is helping the US in their way out of the funding shortage, where we see the beginnings of new issuances of CMBS. Although it is nowhere near the levels seen over recent years, it is nonetheless an indication of life returning to the market, which should support new funding (Figure 8).

Figure 8

New CMBS issuance, 2008-YTD 2010

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Source: Bank of America Merrill Lynch, CREFC

In Europe new CMBS issuance has not shown the long waited signs of revival yet. Here differences in the structure of loans is delaying any recovery. The issuance that we have seen has been restricted to just a handful of deals where the underlying tenant covenant has been the driver rather than the asset. Still the prospects for a real recovery in Europe remain thin. Here, the only alternative to bank lending is through the covered bond market which accounts for 18% of current outstanding debt (Figure 7). However, this is heavily dominated by the German Pfandbrief market, which is the only real source of new lending and refinance in the current market. In its absence, European lending markets would be in an even more perilous position.

Lending terms provide immunity Further differences among the regions relate to lending practice and loan terms. These can provide some immunity


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to the debt funding gap in some cases, or restrict solutions in others. As we highlighted in section 2, loan length is of great importance. Longer maturities can protect from the short term volatility in capital values. As property tends to be cyclical it is likely that values revert to their mean in the long run. The US tends to have longer loan maturities that have so far been insulated against the recent falls in values. Although this cannot provide a solution to the current debt funding gap, we might see the adoption of such practice in European and Asia Pacific markets in the future, especially as regulatory pressures increase. The high cost of breaking swap contracts has proved to be a significant liquidity barrier. Contracts which are longer in length than the underlying loan are most at risk. But these are likely to diminish as the swap breakage cost is directly linked to the outstanding length to maturity. An alternative solution could be an increased use of fixed rate loans. Another way to protect against a future debt funding gap is the increased use of fully amortising loans. By amortizing the principal during the loan term, the outstanding balance reduces as loans get closer to maturity, reducing the refinance risk. Again such practices are more prevalent in the US.

Regulatory changes to affect decisions Although banks and borrowers have not been forced to engage in more dramatic solutions, potential changes might affect their decisions in the short term. Those changes relate to both the equity and the debt side:

As governments focus more and more on their sovereign deficits and debt, a potential unwinding of accommodation policies will put weight on banks to deal with their most problematic loan positions.

Although the Basel III reserve requirements do not kick in until the end of the decade, they will impose stricter capital requirements. These also include new regulations that will discourage banks from securing funding from the CMBS markets, while encouraging them to access the covered bond markets.

Further regulatory reforms, including Solvency II, new rating rules, the EU Alternative Investment Fund managers Directive, the Dodd-Frank reform and Consumer Protection Act present further challenges in the years to come.

Interest rates are currently at record low levels. Any increase will deteriorate the position of the more struggling borrowers and force them to find a solution.

Banks have committed to restructure and reduce exposure in the property sector within a particular timescale. We therefore expect to see more activity from banks to bring about solutions going forward in an orderly fashion. Every case is likely to be treated individually. Discussions between borrowers and banks should begin at the early stages of the refinancing requirements as trust is essential to an effective and fair solution between the two parties.

Secondary assets most exposed The quality of the collateral is also of significant importance, with secondary properties likely facing a much higher refinancing risk than the prime ones. This reflects the fact that values on secondary assets have been more exposed in the current downturn. Peak to trough in the UK, values on secondary assets have fallen more than on prime. Added to this the value of secondary assets have not recovered as much as prime, leaving these assets more exposed. Given the risk aversion in the markets, investors are seeking only prime properties with demand for secondary ones remaining very thin. This is clearly evident when comparing the upper and lower quartile yield movement on the IPD UK index. This also indicates that investors are more likely to enter loan positions backed up by better quality assets rather than riskier ones.

Figure 9

UK prime v secondary yield movement

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Prime/secondary spread All Property Prime Equivalent Yield

All Property Secondary Equivalent Yield

Source: IPD, DTZ Research

For a borrower, a larger fall in value means there is a greater chance of the equity being wiped out. In such instances they are unlikely to be willing to put in any capital expenditure leading to a possible further deterioration in the asset and possibly the income stream. In such cases banks will be less willing to refinance placing greater pressure on the borrower to plug the gap or face foreclosure.


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Appendix: Revised methodology Our approach to estimating the debt funding gap is broadly unchanged on our last report. In Figure 10 we highlight the six key steps to estimating the debt funding gap based on one single loan.

Figure 10

Estimating the debt funding gap

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Asset value 2011

Debt available Funding gap 2011

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b

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In the above example we calculate the gap for a single loan in the UK as follows:

a) Loan of £100m granted in 2006. b) Value of assets financed total £116m, assuming

an LTV of 86% in 2006. c) Loan due to mature in 2011 (five year term). d) Based on capital value changes

4 from the IPD

index and our forecasts, we estimate that values will have fallen by 32% (£37m) over 2006-2011.

e) The resulting asset value at 2011 is £79m. f) In 2011 we estimate that debt of £58m will be

available for refinance based on a 73% LTV. g) The debt funding gap of £42m is the difference

between the value of the original loan (£100m) and the estimated debt available for refinance (£58m).

In reality we are dealing with a multitude of loans, originated in different years and of differing maturities. In contrast to our previous paper, we also need to account for a proportion of loans to be extended. The following describes in more detail how we reached our numbers based on the above process, step-by-step. Please note some of the charts relate to a specific country.

4 We ignore any impacts from depreciation in our analysis.

Step 1: Calculate outstanding commercial real estate debt by origination vintage Our starting point has been to take data for the UK using De Montfort University’s (DMU) lending survey. From the data we know the originations (in bank lending and CMBS) for each year, and from these we deduct what has matured before 2010. For the purpose of this analysis we are only interested in the sum of originations which equate to the outstanding amount as at end 2009 (Figure 11).

Figure 11

Loan origination profile

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17%

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x 2009 2008 2007 2006 2005

£bn

Source: De Montfort University; DTZ Research

Compared with our previous study the proportion of loans originated in 2009 was higher than we previously estimated (17%), compared to our previous estimate (6%). With a higher proportion, and hence value, of loans originating in 2009, our analysis now goes back to 2005, rather than 2004. We assume that the origination of European and Asian loans follows the same pattern as the DMU data, and apply these proportions to the total outstanding debt secured against properties in each country taken from our Money into Property database, including the UK for consistency, as at the end of 2009. In this way, we look at the debt underlying the properties in each market, rather than the country in which the loans were originated. For example, 26% of the outstanding debt in the UK originated from 2006. We therefore assume 26% of debt originated in this year, in each country. In this way the 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 are


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traditionally longer, averaging around 10 years, we have extended the period we cover in the US to 2001. This way we capture the majority of maturities over the forecast period. Step 2: Estimate refinancing requirements by origination vintage The next step is to calculate the refinancing requirements using the loan originations calculated in step 1. The DMU study provides data on the duration of loans by origination vintage in the UK up to 2009. In order to complete the analysis to 2013, we have made assumptions on the loan duration of loans in 2010-2012 (Figure 12).

Figure 12

Loan duration by origination vintage

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1-y 2-y 3-y 4-y 5-y 6-y 7-y 8-y 9-y 10-y

2005, 2006, 2007, 2009

2011, 2012 prev.

2010, 2011, 2012

2008, 2009 prev.

Source: De Montfort University; DTZ Research

With full data now available for 2009, we can see that the profile of durations in 2009 differs from what we previously assumed, i.e. rather than having a higher proportion of shorter term loans, the profile is actually closer to that seen in the peak of the market. As a result, we have also adjusted our future loan durations to more closely align with what we have seen historically, rather than the gradual adjustment to this trend in our previous analysis. Applying these loan durations to the loan originations we create the future maturity profile (Figure 13). We assume the same profile for CMBS and for loans across Europe and Asia Pacific. In the US we have used data on CMBS loans from Bloomberg to create a loan duration series to 2006. For future years we have assumed the same profile as for 2006.

Figure 13

Maturity profile of loans by origination vintage

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2011 2012 2013

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2006

2005


As outlined in section 1, we also know that some loans are being extended at maturity for an average of two and a half years and varying in length between one and five years. The value of these loans needs to be pushed into future maturities in order to estimate the amount of debt available. We have assumed that 50% of loans extended are for a period of two years, 20% for three years and 10% each for a period of one, four and five years. This gives an average extension of two and a half years. In 2009 we know two-thirds of loans were extended. We assume a gradual reduction in the proportion of extensions to zero in 2013 on a straight line basis (Figure 14).

Figure 14

Profile of loan extensions

67%

50%

33%

17% 10%

50%

20%

10% 10%

0%

10%

20%

30%

40%

50%

60%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2011 2012 2013 1-y 2-y 3-y 4-y 5-y

Loans extended Loans matured Extension profile (RHS)

Source: De Montfort University, DTZ Research

Allowing for extensions, we see an adjustment to the maturity profile. This is best shown by taking the example


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of the single loan we highlighted at the start of this report. In this example, the first four steps of the process remain the same (Figure 15). Thereafter we see some small changes.

e) By extending the loan by a period of two years from 2011 to 2013, we benefit from a further uplift in capital values.

f) In this case values improve by 3% to £82m. g) With a marginally higher LTV of 75% we can

borrow more (£61m). h) The resulting debt funding gap is marginally lower

(-7%) at £39m.

Figure 15

Estimating the debt funding gap with extensions

0

20

40

60

80

100

120

2006 Loan Fall in value 2006-11

Asset value 2013

Debt available

2013

Funding gap 2013

US$m

c

a

b d

e

fg

h


The resulting maturity profile is outlined in Figure 16 and clearly shows the shift in maturity to later years.

Figure 16

Maturity profile before and after extensions

0

20

40

60

80

100

120US$bn

2012

20112010

2009

2008

2007

2006

2005

2011 2012 2013

Beforeextensions

Afterextensions

Beforeextensions

Afterextensions

Beforeextensions

Afterextensions


Step 3: Estimate original property values by origination vintage Based on historic maximum loan to value ratios (LTVs) at the all property level from the DMU survey, we can calculate the value of the underlying assets in each year (Figure 17). We have assumed LTVs are similar in most markets in Europe and made assumptions from local offices for markets in the Asia Pacific region. In the US, we have made adjustments from CMBS loan data from Bloomberg.

Figure 17

Original property values by origination vintage

84% 87% 86% 84%

72% 72% 73% 74% 75%

60%65%

70%75% 75%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

20

40

60

80

100

120

140

160

180

200

2005 2006 2007 2008 2009 2010 2011 2012 2013

LTV %US$bn

Loan origination Implied equity

Max LTV (RHS) Max LTV (March report) (RHS)


Step 4: Estimate future property value to be refinanced Applying capital value changes to each of the assets underlying the loans by vintage and the known maturity profiles we can calculate the future value of the underlying assets. For the UK we have applied capital value changes from IPD as this provides a better proxy for the market as a whole. In continental Europe and Asia Pacific, IPD’s coverage and history is not as extensive, therefore we have derived an All Property series based on our own prime capital values for each country. For both series we apply our own forecasts, which provide us with the value of assets to be refinanced in future years. In the US we have used a capital value series from the MIT/ NCREIF transaction index, which provides a better proxy for the overall market. To this we have applied our own forecasts for prime capital values going forward.


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Step 5: Estimate available debt for future refinancing based on future LTVs Taking the value of assets for refinance (step 4), and applying our estimates for LTVs, we can calculate the value of debt that we estimate to be available (Figure 18). In our previous research we assumed that LTVs had fallen to 60% in 2009. From the 2009 DMU survey we know the average LTV was in fact higher at 72%. In future years we have assumed a gradual recovery to 75% in Europe and the US. In Asia Pacific we assume a recovery to 70%.

Figure 18

Estimating the value of debt available in the UK

67

92

112

49

68

84

72%

73%

74%

75%

76%

0

20

40

60

80

100

120

2011 2012 2013

LTVUS$bn

Value of assets for refinance Debt available max % refinancing LTV (RHS)


Step 6: Calculate funding gap between existing debt refinancing requirements and debt available The final step is to calculate the debt funding gap. We do this for each individual year by deducting the value of debt available (step 5) from the value of loans for refinance in each year (step 2). The sum of all the positive values leaves the total value of equity required – the debt funding gap (Figure 19). In this analysis we have used the years 2011-2013 to provide a forward looking view, even though 2010 is a forecast year in our analysis.

Figure 19

UK debt funding gap

61

87

107

49

6884

12

18

24

0

20

40

60

80

100

120

2011 2012 2013

US$bn

Refinancing requirements (Step 2) Debt available Debt funding gap

2011 2012 2013


www.dtz.com

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. Any such reproduction should be credited to DTZ.

© DTZ 2010

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