The mezzanine real estate debt market in Europe is maturing, driven by increased lender competition and pricing stabilization, which should generate greater activity in 2011 and beyond according to a new report by CB Richard Ellis.
At the height of the crisis, expecting a surge of distress, lenders sought opportunistic returns of 20%-25% for providing mezzanine financing on core assets in prime locations. At this time, over 100 potential participants expressed interest in the market. However, these types of opportunities never emerged and lenders had to either broaden their investment criteria, adjust their return expectations to better suit the product targeted, or exit the market. Some also chose to gain their exposure by investing indirectly into debt funds.
There are now 69 lenders active in Europe today. While CBRE identified nine categories of lender, discretionary asset managers (private equity shops, specialist debt funds and other investment funds) account for just over half of all participants (51%). However, it is expected that the market will rationalize further as it evolves, reducing the pool of lenders to a smaller, but committed, core.
The growing maturity of the mezzanine debt market is also evident in a more highly segmented market. As well as providing additional finance on more stable assets, lenders are able to target 'riskier' assets (with appropriately priced debt). The market is slowly becoming more diversified with certain players willing to take and appropriately price different types of risk. Across the spectrum of lenders, average returns sought now stand at 15.9%.
Although mezzanine transactions are not widely publicized, CBRE estimates that, on average, loans originated over the last five quarters covered LTVs of up to 75%. There are signs that this level is increasing and the average maximum LTV lenders state that they are currently willing to provide financing for is 82.8%.
The UK and Germany, perceived as having the most liquid markets, are expected to remain the markets of interest to lenders, with France and the Netherlands following on in the league table. Virtually all (97%) of the lenders surveyed would finance UK based assets, although only nine are focused exclusively on the UK.
Commenting, Eleonora Pulci, Associate Director, Debt Advisory, CBRE Real Estate Finance, said: "The European mezzanine debt market is at a fascinating stage appetite now exists on both the demand and supply side of the equation. The greater correlation emerging between investor expectations and market realities for borrowers should see more deals done utilizing mezzanine debt in the future.
"We also expect the market to rationalize further resulting in a smaller core group of committed lenders and an ongoing stabilization of risk adjusted pricing, which may see an increasing number of lenders seeking returns of around 10-15%.
"With certain players now willing to take and appropriately price different types of risk, mezzanine finance can now be considered a real option for borrowers to secure additional capital to finance asset acquisitions or refinance existing deals, bridging the funding gap. However, we will undoubtedly see many changes before a 'conventional' market is established."
This report, the first of its kind, has been compiled by CB Richard Ellis' Debt Advisory team to monitor the capacity of the EMEA market and will now be published twice a year.