Nothing is shorter than the memory of greedy investors. In Germany, that well-worn adage applies to the overheated market in commercial real-estate financing. Faced with shrinking profit margins and pressure from new competitors, banks have grown reckless (some might say desperate) by throwing cheap money at risky property investments. Soon, somebody could get hurt.
“We see that increasingly, high risks are being taken on with conditions that simply don’t match the risk involved,” noted Detlef Hosemann, chief financial officer at Helaba, a large German commercial bank.
This brings back unpleasant memories for German bankers. A decade ago, doubtful commercial loans helped sink banks such as Hypo Real Estate and Eurohypo, causing massive losses and forcing costly bailouts in the process.
Today’s most aggressive lenders include ING-Diba, Postbank and HSH Nordbank, according to industry sources. The banks, however, say they know what they’re doing. “We offer our customers fair conditions on fundamentally low-risk investments,” claimed a spokesman for Postbank, the troubled retail banking unit of Deutsche Bank. Peter Axmann, head of commercial lending at HSH Nordbank, told Handelsblatt that the bank, unlike many others, had recently stiffened its loan standards.
“High risks are being taken on with conditions that simply don’t match the risk involved.”
Competition in the sector has hit a new peak. “Tougher than it’s ever been,” said Andreas Pohl, boss of Deutsche Hypo, a subsidiary of NordLB, one of Germany’s largest regional banks. This is partly due to new competition. Returns on many traditional types of assets (such as government and corporate bonds) remain so low that insurance companies and pension funds are piling into commercial real-estate to compensate.
Last week, Allianz Real Estate – a subsidiary of Europe’s second-largest insurance company – announced it was making a €300 million ($352 million) loan to a client seeking to buy an office development in the La Défense financial district of Paris. That borrower was Oxford Properties, a unit of the OMERS pension fund for government employees in the Canadian province of Ontario. This week, the same fund shelled out €1.1 billion for Berlin’s Sony Center, an upmarket complex of offices, retail and nightlife.
Germany’s savings and cooperative banks, which previously focused on retail operations, are looking to get in on the act. But banking supervisory authorities question the logic of these plans. “In Germany right now, it’s difficult to reconcile risks with appropriate risk premiums,” said one regulator. But for reasons unknown, authorities are still relaxed about market conditions.
Unsurprisingly, borrowers are delighted. “These days, Germany is a paradise for anyone borrowing to buy or build commercial property,” said Roberto Carrera, head of debt financing at Lasalle Investment Management. Clients looking to buy a finished building can expect to pay interest just 1 to 1.3 percentage points above the 3-month Euribor, the benchmark rate at which banks themselves borrow money. That is 0.30 to 0.50 point lower than last year’s level, which was already considered low.
Some banks are quietly reducing their exposure. On commercial property, the bank’s most important sector, new loan volumes fell 14 percent to €4.2 billion in the first half of this year. Aareal Bank, a German commercial property specialist, says it’s shifting some of its business away from the domestic market. Others are staying in the game: the publicly-owned Landesbank Baden-Württemberg, one of Germany’s 10 biggest financial institutions, says it will issue up to €7 billion in new commercial loans this year, an increase on last year’s total.
If the commercial property market cools, the potential for setbacks is considerable.
With their books filling up with low-yielding loans, banks are increasingly exposed to rises in interest rates. But the financial industry continues to downplay the risks, with bankers insisting that loan criteria remain tight. Mr. Carrera said borrowers must cough up a big chunk of their own cash for any investment, and follow strict rules if the value of their rental income or assets drops.
On average, banks lend only around three-quarters of the cost of a commercial development, said Sebastiano Ferrante, head of German business for Pramerica Real Estate, a large commercial property investor. Mr. Ferrante said that’s somewhat higher than previously, but still considered “conservative.” Prior to the financial crash a decade ago, that rate was over 90 percent, he adds, but stricter regulation has put an end to such ultra-loose lending.
However, the real risk may come from another source. So far, the commercial real estate boom remains unchecked, with prices continuing to rise. Revenues for JLL, a leading service provider for commercial property investors, may exceed €55 billion this year, a new record. Strong demand boosts prices and with them, the valuations of existing commercial property portfolios. But if the market cools – say, due to rising interest rates, or a boom in other assets – the potential for setbacks is considerable.
Banks find themselves in a tight spot. If real-estate prices fall, book values will have to be reassessed, hitting the so-called loan-to-value ratio, a key accounting variable in the banking sector. That, in turn, could prompt banks to require borrowers inject more of their own capital into a loan-financed project. If investors balk at that prospect, the banks could start demanding rental incomes from these properties, in which case, loans historically underperform. That’s what happened 10 years ago, when things unraveled very quickly.
Frank Drost is a Handelsblatt editor in Berlin, covering financial supervision and banks. Reiner Reichel specializes in real estate, closed-end fund and system models. Anne Wiktorin is an editor at Handelsblatt, reporting on finance and real estate from Düsseldorf. Brían Hanrahan and Jeremy Gray adapted this story for Handelsblatt Globle. To contact the authors: firstname.lastname@example.org, email@example.com, firstname.lastname@example.org