OPPORTUNITIES IN DISTRESSED REAL ESTATE

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1 EUROPE, LLP OPPORTUNITIES IN DISTRESSED REAL ESTATE Jeremy Ford, Managing Director, Metropolitan Real Estate Europe, LLP APRIL

2 Disclaimer THE INFORMATION PROVIDED HEREIN IS FOR INFORMATIONAL PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND SUCH INFORMATION INCLUDES FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON CERTAIN ASSUMPTIONS. ANY PROJECTIONS, VIEWS, OUTLOOKS OR ASSUMPTIONS SHOULD NOT BE CONSTRUED TO BE INDICATIVE OF THE ACTUAL EVENTS WHICH WILL OCCUR. CERTAIN INFORMATION CONTAINED HEREIN IS BEING PROVIDED MERELY TO SHOW THE GENERAL TREND IN THE REAL ESTATE MARKET IN THE PERIODS INDICATED ACCORDING TO THE STUDIES CONDUCTED BY OTHER PARTIES. THIS DOCUMENT IS NOT INTENDED FOR PUBLIC USE OR DISTRIBUTION. WHILE ALL THE INFORMATION PREPARED IN THIS DOCUMENT IS BELIEVED TO BE ACCURATE, ( METROPOLITAN OR MRE ) MAKES NO EXPRESS OR IMPLIED WARRANTY AS TO THE COMPLETENESS OR ACCURACY OF THE DOCUMENT, NOR CAN IT ACCEPT RESPONSIBILITY FOR ERRORS APPEARING IN THE DOCUMENT. METROPOLITAN SHALL NOT HAVE ANY LIABILITY TO YOU OR ANY OTHER PARTY RESULTING FROM THE USE OF, OR RELIANCE ON, THE MATERIAL CONTAINED HEREIN. THE INFORMATION PROVIDED HEREIN, INCLUDING, WITHOUT LIMITATION, INVESTMENT STRATEGIES, INVESTMENT RESTRICTIONS AND PARAMETERS, AND INVESTMENT AND OTHER PERSONNEL, MAY BE MODIFIED, TERMINATED OR SUPPLEMENTED AT ANY TIME WITHOUT FURTHER NOTICE. Experience Access Diversification 2

3 Your Daily Dose Of Distress Lloyds reduces problem loan exposure by 5.35bn PropertyWeek Real estate becoming sweet spot for buyout firms The Financial Times Investor risk appetite rises; Europe is now firmly on the radar of opportunistic investors The Financial Times Lloyds and AIB selling off their distressed property loans The Independent Experience Access Diversification 3

4 There Are Distressed Properties Experience Access Diversification 4

5 And, There Are Distressed Owners A range of factors can create distress for otherwise institutional-quality assets Short lease terms Vacancy Low barriers-to-entry Needing refurbishment/redevelopment Poor tenant-mix Blackpool (U.K.) Debt maturity and/or overleverage Boston, MA (U.S.) Minneapolis, MN (U.S.) Tokyo (Japan) Helsinki (Finland) Experience Access Diversification 5

6 Less Competition And Anticipated Deal Flow Contributes To Market Dislocation 1. Severe Market Dislocation Opportunities to participate in restructuring and recovery Recovery will be slow and uneven, might take several years 2. Fewer Buyers Flight to quality Assets neglected, need skill to assess and reposition 3. More Sellers Distressed and unnatural owners Greater inefficiency in process Large supply of over-leveraged assets coming to market Experience Access Diversification 6

7 Creating Interesting Opportunities For Buyers Mispriced risk and local knowledge can create asymmetry Lower basis, especially versus core, confers downside protection and leasing advantage Yields potentially higher than core yields, more so on stabilization; reaffirms downside protection Hard assets with meaningful upside potential in event of inflation or stronger economic outcome Experience Access Diversification 7

8 We ve Seen This Before A financial (structural) problem rather than a real estate problem (cyclical) ADVANCED ECONOMIES GDP GROWTH AND REAL ESTATE CYCLES ( ) % change 1970s Oil Crisis 1980s Recession Early 1990s Recession Dot Com Bubble Early 2000s Recession GFC Oversupply absorbed Demand/ supply matched Undersupply RTC 2 Oversupply Oversupply Oversupply Source: FDIC, FDIC Structured Transaction Fact Sheet, IMF, FW Dodge, CB Commercial, BLS, Mueller. Experience Access Diversification 8

9 We ve Seen This Before A financial (structural) problem rather than a real estate problem (cyclical) RTC TODAY Inefficient Efficient Bulk sales ( Black box ) Retail flip Discrete portfolios and oneoffs Value created through active asset management Experience Access Diversification 9

10 Significant Increase In Lending Through 2007 With Loans Maturing Now EUROPEAN LENDING TO REAL ESTATE ( BILLION) 323% B Billion % U.S. CMBS SALES AND MATURITIES ($ BILLION) Majority of European real estate debt exposure through direct balance sheet debt exposure (75%) and bank sponsored covered bonds (18%) Mostmortgagesremainonbanks booksasthey extend loan terms in hope values will improve Lack of alternative funding when debt maturities at their highest $ Billion 150 $320B Lending Maturities Source: CBRE, De Montfort University, January DTZ May 2011,. Experience Access Diversification 10

11 Faster Than Anticipated Reduction And More To Come PROGRAM OF ANNOUNCED SALES (TOTAL OF 296 BILLION) Banks 37% REITs 5% Government 30% CMBS 17% OEFs 11% IMPAIRMENTS MADE BY A U.K. BANK TO NON-CORE PORTFOLIO ( BILLION) Pressures mounting on bank balance sheets as nonreal estate assets deteriorate Banks ~20-25% through their revised deleveraging plans by mid-2012 (majority through repayment of loans and impairments, fewer disposals) Projected that by the end of 2015 a majority of the work-out will be completed 40 Billion H09 2H10 4H10 2H11 4H 11 2H12 Source: Morgan Stanley, November 2012, J.P. Morgan Asset Management as of December 2012, J.P. Morgan Asset Management, February Experience Access Diversification 11

12 The Size of the Opportunity in Europe EXPECTEDOPPORTUNISTICSALES IN EUROPE (TOTAL OF 261 BILLION) Investment activity by opportunistic investors rose to 12% of all investment activity in Europe in 2012 (versus 6% average from ) Opportunistic segment of market expected to increase to ~15-20% of total capital invested DISTRESSED SALES IN THE U.K., GERMANY AND FRANCE (SOURCES) (TOTAL OF BILLION) Banks 77.1B REITs 3.2B Govt 24.5B CMBS 14.3B OEFs 6.7B Source: J.P. Morgan Asset Management, February 2013, CBRE Valuation Team, September 2012; J.P. Morgan, September Experience Access Diversification 12

13 Investors Can Access Distress Throughout The Capital Structure Distressed Equity Individual, non-core properties sold out of portfolios in need of active asset management Properties in need of capital for renovations or tenant improvements held by capital constrained owners or unnatural owners (e.g., banks) Opportunities to restructure balance sheets and provide new capital Acquire properties through loan-to-own situations Distressed Debt Opportunities include large portfolios as well as individual assets Complex transactions that require structuring capabilities Illiquid debt environment creates mispriced segments in the capital structure Sources include banks, borrowers (owners), property developers; relationships with lenders and borrowers key to successfully sourcing transactions Sources include forced sellers, including closed-ended funds, banks, open-ended funds, corporations, governments, REITs Experience Access Diversification 13

14 Utilizing Different Skill Sets Asset Transaction Buy assets at a substantial discount to their intrinsic long-term value Focus on non-core ( B ) assets which can be returned to core Purchase income target assets with relatively high current yields and attractive risk adjusted returns Financial Transaction Look at assets that are neglected due to capital constrained or unnatural owners Provide capital (i.e., loan origination, bridge financing, development financing, etc.) Debt Transaction Buy distressed properties through loan-to-own situations Restructure/recapitalize balance sheets on overleveraged assets Take advantage of illiquid debt environment to access segments of capital structure that are mispriced due to risk (i.e., mezzanine loans, etc.) Experience Access Diversification 14

15 Distress Can Be Sourced From Banks And Borrowers LOCATION Berlin & Northern Germany London, U.K. Western Germany ASSET TYPE NPL portfolio secured by residential properties Office building Small portfolio of retail assets SELLER Consortium of European banks Diversified fund manager Two German banks SELLER S RATIONALE Seeking long term partner with: Viewed the asset as a noncore part of portfolio Willing to take a write down - Real estate knowledge and track record in Germany - Ability to asset manage and invest capital Short lease length Willing to sell substantially below replacement cost Prepared to provide new financing MANAGER S STRATEGY Structured transaction Tap into strength of single transaction market Limit risk by receiving disposition fee senior to the senior lender Value add Negotiate lease extension Decrease vacancy Secure financing Value add Extend lease terms Lease vacant space Exit via institutional market Experience Access Diversification 15

16 Creatively Structured Transactions LOCATION Boston, MA Minneapolis, MN Washington, D.C. ASSET TYPE Loan-to-own office building Mortgage collateralized by Class-A retail asset Mezzanine loan SELLER Two banks Asset manager Bank SELLER S RATIONALE Loan maturity; loan couldn t be repaid in full Borrower defaulted on payment and went into foreclosure Senior and mezzanine loans went into maturity default MANAGER S STRATEGY Structured transaction Foreclosed at significant discount to prior owner s basis Reposition as premier office address Manage tenant rollover Structured transaction Recapitalized an overly leveraged, high quality asset High unlevered debt yield Structured transaction Sourced off-market through relationship with lender Loan acquired at significant discount to face value Generating good income Additional upside in residential development rights Experience Access Diversification 16

17 Debt And Equity Opportunities LOCATION Tokyo, Japan Hong Kong, China Tokyo, Japan ASSET TYPE Loan acquisition with access to large hotel portfolio with sale-leaseback structure Underperforming office building SELLER Japanese bank Hong Kong listed property development and investment company SELLER S RATIONALE MANAGER S STRATEGY Selling performing loan after borrower was unable to refinance the loan Structured transaction Acquire performing loan at significant discount In-place, contractual cash flow Reduce risk by using a leading hotel operator Rebalancing of assets for balance sheet purposes Value add Renovation Reposition to boutique, managed office Increase rental rates Exit to local, core-plus investor Small portfolio of mixed-use assets Distressed seller Bank forced sale of highly leveraged asset and provided financing to higher quality borrower Value add Manage near term lease rollover Stabilize the portfolio Secure financing Identify a buyer Experience Access Diversification 17

18 Keys To Success Real Estate Knowledge Understand local/regional market dynamics Recognize real estate value Remain cognizant of supply and demand dynamics Financial Know How Utilize modest leverage and sound borrowing practices Achieve significant discounts through critical mass Understand complex financial structures Run an efficient bidding process Maintain credibility and have realistic pricing expectations Operational Skills Manage and increase property cash flow Maintain and develop deep tenant relationships to enhance leasing and income Improve control over outcome and cost through vertical integration with inhouse renovation, repositioning, and construction expertise Build relationships with lenders, buyer, and sellers Experience Access Diversification 18

19 EUROPE, LLP