Vendors of commercial property assets are bulking up lot sizes through aggregation. Why the relatively sudden move to larger lot sizes and the payment of the elusive ‘premium’?

OVERVIEW

In America, portions are notoriously big. As U.S. private equity continues to dominate the buying market in terms of direct property transactions and non-performing loan acquisitions alike, this philosophy has now reached UK shores and will no doubt soon spread into Continental Europe. In previous markets a portfolio lot size which was considered to be too large would often mean the exclusion of a number of buyers. Currently, the majority of the named demand in the market could easily write cheques approaching £1 billion for the right stock. Stock selection to these purchasers is defined less by property fundamentals, and more by motivated vendors and an attractive critical mass.

WHY THE LARGE APPETITE FOR SUCH PORTFOLIOS?

Competition for large portfolios from both interested vendors and buyers is such that for the larger bank portfolios, purchasers are willing to pay a premium over and above the pricing levels they would be willing to pay for the same portfolio offered by a ‘profit taker’. This perceived market premium for large portfolios has led to a number of banks following the example set by Lloyds Banking Group, Eurohypo and the Royal Bank of Scotland in deleveraging in substantial swathes, rather than a sell-down of individual assets.

The advantages of deleveraging in such a way are clear. Firms which offer due diligence services can ensure certainty for both sellers and purchasers by providing a central platform on which to validate the assets of a large-scale project. Timing can also be significantly reduced, with the bidders having large teams of underwriters often working around the clock to research all of the information available and who can offer educated views where there are missing elements of due diligence.

MARKET LEADING PORTFOLIO TRANSACTIONS

Jones Lang LaSalle (“JLL”) and DLA Piper have been at the forefront of this market dynamic by performing key real estate as well as non-performing loan trades, thereby providing banking clients with a validated deleveraging tool as a deliverable alternative.

Project Moon

The first major transaction undertaken by the two firms was Project Moon in December 2013, an aggregation of different loans where control was undertaken by JLL as Fixed Charge Receivers and a single portfolio sale of circa £400 million was achieved. The transaction took only 11 weeks to complete. The two firms continue to collaborate on such matters; in the impaired debt space they together have either closed or are in the process of closing a further £750 million in portfolios this year.

PORTFOLIO PRICING

For the purchasers of these portfolios UK real estate looks attractively priced considering risk profiles. In buying a larger portfolio the purchaser can benefit from economies of scale, spread of tenant risk, and gain exposure to a market expecting to benefit from rental growth. With many of the purchasers based overseas, there is often an additional benefit from exchange rates.

Availability of debt is also driving portfolio pricing, with banks providing most aggressive terms to reputable borrowers on portfolios which present a balance of risk. Loan to values have been achieved for traditional senior debt of up to 75% with all in costs of borrowing of below 4%, for large secondary portfolios. The availability of mezzanine funding has become similarly liquid and there is clear evidence of the emergence of the Securitisation market which will add increased liquidity into this space.

Portfolio volumes exceeded all previous records in 2013 at over £9 billion in 114 transactions. 2014 could exceed these levels, with almost £8 billion transacted in 116 deals and a further £1.3 billion in solicitor’s hands at this point in time. JLL have advised on an excess of 30% of these trades.

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In addition to these direct property transactions a further €15 billion of loans were transacted in 2013 in the UK & Ireland. This looks set to increase markedly to €48 billion in 2014. Whilst a fairly large proportion at 32% of direct property was bought by U.S. equity, their share of the non-performing loan market was over 80%, making them the most acquisitive type of portfolio purchase.

The chart below demonstrates the percentage of purchasers of UK direct portfolios (by value). U.S. purchasers fall into the category of ‘Private Equity’:

The above factors have driven the market to a strong recovery over the past 12-24 months.

WHAT NEXT?

With the election looming next year and the ever more distant possibility of rate rises, will the market remain static? The supply and demand metrics clearly indicate against this. The wall of equity demand from U.S. private equity remains and whilst UK banks have deleveraged considerably in recent years, there still remains more bad debt to trade on, with German banks in particular yet to really begin to deal with their problematic assets. The market appetite for large portfolios looks set to continue as both vendors and purchasers benefit from ‘bulking up’.

Richard Stanley, Philip Marsden, Peter Kirk & Peter S. Nicoletti