With real estate investment transactions for 2012 totaling only €120 million and new supply of commercial real estate 75% or more down on historic levels for 2013 and 2014, it is clear that not only has there been a dramatic and necessary response to the oversupply of commercial space but that the availability of domestic bank debt financing is extremely limited.
It would be easy to blame the lack of bank financing on the bank tax and political tensions between the government and foreign owned banks. However, the primary cause of the lack of bank financing to real estate is due to the foreign owned banks illiquidity, exacerbated by the increased capital adequacy requirements of Basle III. As in the early 1990’s recession, it is their natural tendency to withdraw funds from peripheral markets such as Hungary to protect the health and security of their home country core markets.
Clearly also, the large portfolios of repossessed properties which the local banks have accumulated has not only caused them to view real estate financing as high risk but has consumed the time and resources of all of their in house real estate personnel for the last three years.
These causes resulted in a total lack of bank financing for real estate from local banks in 2011, but there were some signs of a trickle of funds coming back into the market by the end of the year. Two international banks were able (after approvals processes of up to 12 months) to provide financing to two large pre-leased office development last year. Of course, the interest rate margin terms are two to three times higher and the ancillary costs of this new debt are at least double what they were five years ago, on top of a maximum of 70% leverage.
So does this trickle of new debt constitute the “green shoots” of a recovery in bank debt financing? Sadly not, in my opinion. The first problem is that very little of the banks repossessed properties have been released to the market at anywhere near realistic pricing levels. With sympathy for the banks reluctance to acknowledge and write down their losses, nevertheless the resulting lack of re-pricing of real estate assets in the market will stall any true recovery indefinitely. However, as the banks are no doubt discovering, the costs of holding these properties will, after two or three more years, exceed the potential loss write down they should ideally have faced between 2010 and 2012. It is only a matter of time therefore, before the banks will be forced to market repossessed stock and take the necessary write downs.
In the meantime, therefore, is the outlook for real estate financing in 2013 completely negative? It does not need to be! Traditionally in mature real estate markets, the lack of bank financing or the high cost of what little is available, creates opportunities for other sources. As mentioned above, the tendency of foreign owned banks to protect their home markets causes a strong argument for expansion of a more local banking market. This is an opportunity which has been identified by the likes of Granit Bank (although they are not yet providing real estate financing). We can also consider sources of private equity and mezzanine financing due to a reduction in the margin between their relative interest rates and costs compared to banks. However, their resources tend to be limited. Where to look then for large sources of alternative debt financing?
Not for nothing has the institutional investment market in the UK and Germany been dominated by insurance companies and pension funds for decades. Typically, such institutions have provided funding, either on a forward purchase basis for developments, or through their diverse fund businesses, to investors of built and let real estate, especially in the prime sector. Generally speaking, they have stepped into the market at exactly times like these, at the bottom of the value cycle, when the perceived and actual risks of value loss for their more conservative clients are limited.
In Hungary so far, this is a sector has largely failed to materialize. The reason is that it has been inhibited by past, well intentioned risk averse government regulation, which limited the extent of funds allowed to be allocated by insurance companies into real estate investments. In the continued absence of bank debt financing for real estate, therefore, it would be well worth the time of a government which wishes to revive this sector (with its large and direct impact on construction sector employment), to reconsider outdated statutory limitations on alternative sources of real estate financing. I would go further and say that positive encouragement through tax breaks and similar incentives, to investment in real estate by insurance companies and pension funds, would not only benefit the sector and the economy in general but also the long term investment returns of these institutions.