Debt investors’ search for yield and fading concerns about the break-up of the Eurozone have revved up Italy’s commercial real estate loans market to a point where it is unrecognizable from its moribund state two years ago, write Francesca Galante and Cyril de Romance, co-founders of First Growth Real Estate.

The Italian market's rediscovered appeal lies in its attractive risk-adjusted returns, which can be more than double what is available in the crowded and sophisticated UK and German markets.
To understand the magnitude of the shift in sentiment, one needs to remember how bad things were. At the peak of the Eurozone crisis, Italy was so out of favour that hardly any investor was brave enough to consider investing there. As a result, the real estate investment market shrank to less than €1 bn per year. Similarly no conventional lenders would underwrite loans of a certain quantum; the few largescale financings that did occur were funded mainly by pioneering hedge funds, private family offices or financial leasing as part of loan restructurings.

In July 2009, the refinancing of prime Milan retail units with a loan to value (LTV) at 60% and priced at a 9% coupon failed to attract institutional capital. Fast forward to December 2013, when Goldman Sachs securitized €363 mln of loans secured against mainly secondary retail assets, the financing was priced around 525 basis points for an equivalent LTV.

NEW ENTRANTS

Post-financial crisis, European banks are in the process of repairing their balance sheets by scaling back their lending or retreating outright from foreign markets. New entrants, including insurers, debt funds and other non-bank lenders, are jostling to occupy the space. To date, however, the vast bulk of this new capital has focused on the U.K. and Germany, Europe's largest commercial real estate investment markets, which are deep and more sophisticated. Such intense competition has resulted in really squeezed margins, meaning Italy and other continental European markets currently offer much better value and risk adjusted returns to debt investors. We anticipate such margins will continue to decrease as the resuscitated syndication market continues to grow.

For good quality non-prime secondary commercial properties in Italy for a debt quantum above €50 mln - which is large for a local lender alone -- circa 60% LTV senior loans can achieve a 350 - 600 basis point margin. This compares with a 175-300 basis point margin for an equivalent loan in the UK and 150-250 basis points in Germany. For transitional assets, lenders would be market makers and could ask the returns they require.

For mezzanine or subordinated loans, the difference in margins between the UK and Germany with the other European markets can range from 10% to -15%. There is a very sophisticated mezzanine market in the UK/Germany, and virtually none elsewhere. Mezzanine investors on the Continent (excluding Germany) can still achieve double-digit returns, which is now virtually impossible in the UK. In a fixed income world where it is difficult to achieve double digits yields, real estate subordinated debt on the continent is all the more so a very interesting spot to be on a risk adjusted return basis.

LOCAL PARTNERS

The reluctance of international debt investors to lend in continental Europe's real estate markets stems from perceptions that these are unsophisticated jurisdictions, dominated by domestic lenders and unfriendly to creditors. While true to a degree, these issues can be addressed. Local or German pfandbrief lenders, when open for business, tend to focus on the prime side of the property spectrum, lending to institutional sponsors for well-let assets. For anything outside such parameters, capital is severely lacking. To mitigate the need for insider knowledge in markets such as Italy, France or Spain, a specialist local partner is vital for international debt investors to identify the attractive opportunities in its commercial real estate lending market, to avoid the bear traps, and structure appropriately to ensure creditors' rights are protected. With the correct partner, institutional capital providers can invest in debt packages that are specially structured and executed to preserve their rights and challenge borrower-friendly legal protection successfully. It is key to work with local partners who speak the languages, know the cultures and have local business skills allied with Anglo Saxon market practices, discipline and institutional training.

How creditor rights are protected is the most challenging perception issue. For example, Italian enforcement processes are in fact easier to predict than those in France, since the locality of the court sets a clearer pattern on the length of time needed for proceedings, as are those in Spain.
As the flow of capital lined up for commercial real estate across Europe keeps increasing at a very high pace, there are now encouraging signs that the lending markets are also moving in the right direction. Several blue chip institutions have set up dedicated investment vehicles targeting Italy, France and Spain, something that was unthinkable two years ago. Some large-scale loan refinancings are also coming due and it will be particularly interesting to see how the pricing for these evolve.

There are phenomenal opportunities in Italy and elsewhere in continental Europe outside Germany. These opportunities are not out of reach with the support of the right partner to generate attractive risk-adjusted returns.

FIRST GROWTH: Created end of 2009, First Growth is the continental European specialist debt platform. First Growth successfully sourced, structured and arranged over €350 mln of debt capital for investors since mid-2010. Approximately €75 mln of that has successfully repaid ahead of business plan, generating high teen IRRs to mezzanine investors. In addition, First Growth restructures loans for both sponsors (€850 mln to date) and provides special servicing to lenders (with recurring mandates of €1 bn).

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