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DTZ InsightGlobal Debt Funding Gap

Smaller, but pressure remains

5 May 2011

Contents

Introduction 2Global debt funding gap 3Current market status 6Bridging the gap 8

Outlook what happens next? 10Appendix 1 12Appendix 2 13

Authors

Nigel AlmondForecasting & Strategy Research+44 (0)20 3296 [email protected]

Konstantinos Papadopoulos

Forecasting & Strategy Research+44 (0)20 3296 [email protected]

Contacts

David Green-MorganHead of Asia Pacific Research+61 2 8243 [email protected]

Magali MartonHead of CEMEA Research+33 1 49 64 49 [email protected]

Tony McGoughGlobal Head of Forecasting &Strategy Research+44 (0)20 3296 [email protected]

Hans VrensenGlobal Head of Research+44 (0)20 3296 [email protected]

The global debt funding gap is estimated at US$202bn over thenext three years (2011-13). This is a 17% reduction on theUS$245bn we reported in our November 2010 report (Figure 1).

The global reduction is mostly triggered by the US gap ofUS$49bn declining to zero, due to a 6% decline in outstandingdebt and a 9% increase in the 2010 forecasted capital values.Partly offsetting this are Japan, France and Ireland which sawincreases in their gaps. But, Japan, the UK, Spain and Ireland

continue to have the largest absolute and relative gaps globally.

US$403bn of equity available for investment over the next threeyears. This is up by 7% from our earlier estimate and has nowincreased to double the US$202 debt funding gap over the sameperiod.

Efforts are now well underway on both the debt and equity sideto bridge the shrinking debt funding gap, particularly in Europe.Loan provisioning has the potential to cut Europes debt fundinggap by 8% to US$109bn from US$118bn. Additional lending

capacity to refinance loans is available from US$80bn of newequity available from insurance companies.

Our outlook on the market focuses on continued pressures onbanks to delever, particularly in the UK and Ireland. Thesepressures are likely to increase as central banks unwind theirliquidity supports in the next year or so. Furthermore, regulatorychanges are expected to reduce bank lending (Basel III) andincrease non-bank lending (Solvency II). Further diversification offunding channels is essential for growth in non-US lending.

Figure 1

Debt funding gap by region, 2011-2013

126 118

70 84

49

0

50

100

150

200

250

Nov 2010 May 2011

US$bn

Europe Asia Pacific North America

245

202

% change

- 17%

- 100%

+ 20%

- 6%

Source: DTZ Research


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Global Debt Funding Gap

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Section 1: Introduction

This is the second edition of our Global Debt Funding Gapreport, which provides an update to our previous report inNovember 2010 and the European Debt Funding Gapreport we published in March 2010

1.

In this report we have extended our analysis to includeCanada. We also provide an update to our previousanalysis reflecting the outstanding debt for each countryfrom year end 2009 to year end 2010 (see Appendix 1 formore detail on the reporting by Central Banks). Globally,

lending secured by commercial property has changed littleduring 2010. This reflects 15% growth in lending inemerging countries across Asia Pacific, notably in Chinaand India. In contrast, both Europe and North Americahave seen a 5% reduction each in their outstandingamounts (Figure 2).

We have also incorporated our latest forecasts for capitalvalue growth. Our methodology for estimating the debtfunding gap remains unchanged on last time (seeAppendix 2 for more detail). We continue to define the debtfunding gap as the gap between the existing debt balanceand the debt available to replace it.

This report is divided into four key sections. In the nextsection we update our debt funding gap analysis andhighlight those countries and regions most exposed. Insection 3 we outline some of the solutions underwaybefore examining in more detail how some of thesesolutions and available equity will reduce the debt fundinggap (section4). Finally in section 5, we provide our outlookfor the market.

Figure 2

Global outstanding debt to real estate by region

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2007 2008 2009 2010

US$bn

Europe North America Asia Pacific

6,934 6,815 6,806

% change

2009 -2010

0%

+15%

-5%

-5%

6,298


1 See Global Debt Funding Gap new equity to plug into messy workout,DTZ Research, 24 November 2010; European Debt Funding Gapresolutions underway, DTZ Research, 29 March 2010


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Section 2: Global debt funding gap

We estimate the global debt funding gap to be US$202bnover the next three years (2011-2013). This is equivalent tojust 9% of the loans set to mature over the same period.The figure is also a 17% reduction on the US$245bn wereported in our November 2010 report.

The reduction in the global figure masks some variations ata regional level (Figure 3). Both Europe and North Americahave seen a reduction in the debt funding gap. In the

United States the debt funding gap has fallen to zero over2011-13 (see Box 1).

In Europe we have registered a moderate fall in the debtfunding gap of US$8bn to US$118bn over the next threeyears. In contrast, Asia Pacific has seen its debt fundinggap increase US$14bn to US$84bn, with the majority ofthis in Japan.

Figure 3

Debt funding gap by region, 2011-2013

126 118

70 84

49

0

50

100

150

200

250

Nov 2010 May 2011

US$bn

Europe Asia Pacific North America

245

202

% change

- 17%

- 100%

+ 20%

- 6%


Box 1: Where has the US funding gap gone?

In our previous research, the US had one of the largestabsolute debt funding gaps at US$49bn (although just 1%of its invested stock). In our updated analysis the debtfunding gap has fallen to zero. But why such a big fall?

Our starting point in the analysis is the amount of debtoutstanding to commercial real estate. At the end of 2010,this totalled US$2,408bn, 7% lower on a year ago. Ourestimate for capital growth in 2010 was also revised upsignificantly, from an estimated -1% to a positive 9%,supported by strong fourth quarter capital value increases.This reflected stronger yield compression and somestronger rental growth in selected markets, which weexpected to come through later in our forecasts.

Canada also has no debt funding gap. This reflects longerloan maturities, as in the US, and lower LTV levels.Canada has also not suffered the volatility in capitalvalues.

The lending market is also more diverse in the US, ashighlighted in our previous report. There, banks accountfor 55% of the outstanding debt, with CMBS (22%) andinsurers (21%) largely making up the remainder (Figure 4).

Figure 4

Outstanding debt by lender type year end 2010

55%

75%

96%

22%

6%

4%

21%

2%

18%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

North America Europe Asia Pacific

Banks CMBS Insurance & other institutions Covered bonds


This diversity means the lending market is less reliant onjust one main source of finance. With life insurers

becoming particularly active again and the CMBS marketopening up, the refinancing of loans is less of an issue. InEurope banks make up 75% of lending with coveredbonds, which are also issued by banks, a further 18%. Thelack of alternative funding channels means lendingmarkets have struggled to open up.


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Japan, the UK and Spain continue to have largestabsolute gaps

At a country level, Japan has the largest debt funding gapat US$84bn; this is a US$14bn increase on our previousreport. This reflects an increase in the amount of debtoutstanding to commercial real estate since our last report,up 10% since the end of 2009 to US$757bn. Our outlookfor capital values in Japan has also been downgraded inthe near term following the earthquake and subsequenttsunami.

The UK has the second largest debt funding gap atUS$42bn. This is US$12bn (22%) lower than the US$54bnreported last November. Spain also has a high debtfunding gap of US$28bn, 14% lower on the US$33bnreported in November. Irelands debt funding gap alsoremains elevated at US$12bn. Other than France, whichhas a debt funding gap of US$10bn, the remaining marketsall have debt funding gaps below US$10bn (Figure 5).

Figure 5

Debt funding gap by country, 2011-2013

0

10

20

30

40

50

60

70

80

90US$bn

Nov 2010 May 2011 Source: DTZ Research

Ireland most exposed on a relative basis

As we have highlighted in previous reports, the absolutedebt funding gap is not an entirely reliable measure as itignores the relative size of individual markets. Measuringthe debt funding gap against the countries invested stockis a more appropriate measure.

On this basis Ireland is the most exposed, with its debt

funding gap representing 19% of its stock. This is followedby Hungary (8%) and Romania (6%), although bothmarkets have low absolute debt funding gaps of US$2bn(Figure 6).

Figure 6

Debt funding gap as a percentage of invested stock

Japan

UK

Spain

Ireland

FranceItaly

Germany

RomaniaHungary

Sweden

South KoreaNew Zealand

Norway0%

5%

10%

15%

20%

25%

0.0 0.1 1.0 10.0 100.0

DebtFundin

gGapas%InvestedStock

Debt Funding Gap 2011-13 US$bn (log scale) Source: DTZ Research

Japan and Spain have debt funding gaps of 6% relative totheir invested stock, followed by the UK at 5%. France,which has the fifth largest absolute debt funding gap,reflects just 2% of its invested stock. Germanys debt

funding gap of US$5bn is equivalent to 1% of its investedstock.

Compared to our previous analysis, for most markets wehave seen a gradual reduction in both the absolute andrelative debt funding gaps (Figure 7). This is notably in theUS, as well as in the UK and Spain. In contrast Ireland hasseen its debt funding gap increase on both an absoluteand a relative basis (see Box 2 for why Irelands debtfunding gap has risen).

Figure 7

Debt funding gap as a percentage of invested stock

Ireland

France

Spain UK Japan

US

0%

5%

10%

15%

20%

25%

0.0 20.0 40.0 60.0 80.0 100.0

DebtFundingGapas%InvestedStock

Debt Funding Gap 2011-13 US$bn Source: DTZ Research


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Box 2: Why has Irelands gap risen?

On both an absolute and relative basis the debt fundinggap in Ireland has increased. Why is this?

Our starting point is the outstanding debt secured bycommercial real estate including bank lending, coveredbonds and CMBS. Bank lending figures are reported by theIrish Central Bank (ICB). At year end 2009 this totalled

88bn (Table 1). But, not all of this was secured againstproperty in Ireland. We therefore had to reallocate some ofthis debt to other countries. Equally, we had to account foroverseas investors investing in Ireland, securing debtoutside of Ireland.

We account for this reallocation using our InvestmentTransaction Database, assuming that the debt flows withtransactions. This showed strong activity from Irishinvestors overseas, predominantly in the UK.Consequently, we reallocated a chunk of debt outside ofIreland, leaving a lower amount of20bn (Table 1).

Table 1

Revisions to Irish Debt

ReportedYE 2009

RestatedYE 2009

ReportedYE 2010

ICB reportedoutstanding bank

lending88bn 88bn 72bn*

DTZ estimatedsecured by Irish

property20bn 45bn 42bn*

Debt funding gap^ 5bn 10bn 9bnInvested stock 29bn 56bn 50bn

Debt funding gap

% invested stock16% 17% 19%

*Includes 7.7bn within NAMA; also allows for CMBS and covered bonds

Source: DTZ Research, Irish Central Bank

Following the transfer of loans from the Irish banks toNAMA, we have undertaken a more detailed analysis ofbank lending. This analysis has highlighted two facts. First,data reported by the individual Irish Banks shows theamount of debt outstanding in Ireland is higher than we firstestimated. Second, we also know from their annual reportsthat the two major UK banks (RBS and Lloyds) have a

considerable amount of lending secured against Irishassets. This is because a transaction is not necessarilyrequired to secure debt.

At the same time, we have also seen Irish Banks makesignificant write-downs on loans, notably those transferredto NAMA, leading to a reduction in the outstanding amount.NAMA also does not report to the ICB, leading to a furtherreduction in the amount outstanding reported. We still needto include this in our analysis.

Based on our revised approach, this has led to a re-

statement of the bank lending figures. Consequently ourestimated total debt figure for Ireland rose from 20bn to45bn. On this basis the absolute debt funding gap wouldhave been double at 10bn, equivalent to 17% of itsinvested stock, up from our reported 16%. The smallerincrease on a relative basis reflects the fact that a higherdebt figure, will give a higher invested stock. For 2010 evenif we include the loans transferred to NAMA we have seena marginal reduction in the debt funding gap to 9bn.However, on a relative basis it remains high at 19% (Table1).


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Section 3: Current market status

In countries where the debt funding gap is seen as mostacute, we are starting to see a number of alternativesolutions coming to the fore as banks seek to deleverage.We highlight a number of these in Table 2.

We are also surveying a number of banks globally for theirviews on current and expected lending conditions. Whereloans are unable to be refinanced, the most commonsolution adopted has been to extend the loan with

amendments to the base terms. The injection of equity orpartial repayment of loans were also common solutions.Consensual sales were ranked ahead of foreclosures,although both these solutions were seen as less common.

Writedowns ease, but provisioning remains elevated

Banks account for their problem loans in two ways. Thefirst is for banks to crystallise an actual loss on theirbalance sheet. This is where the sale of a loan orforeclosure has forced them into writing down the loss onthe loan books value.

Loan sales have become an increasingly popular way forbanks to reduce their lending exposures. Until recently,this approach has been common in the US. In the pastyear we have observed a growing appetite for loan sales inEurope and in Japan as highlighted in Table 2, somereflecting heavy discounts to their face value.

In the case of RBS, we have seen sales pared back. Itsoriginal planned sale of 1bn portfolio of Spanish loansresulted in one sale of just 286m, with further separate

sales expected. In the UK it is progressing with a 1.6bnloan sale, down from an initial 3bn of loans.

The fact that both sales are lower than originally intendedsuggests that the appetite across Europe for large loansales is limited. This is in spite of the fact that many of theinterested parties are large US private equity houses.Bradford & Bingley, Lloyds TSB and the Nationwide are allreported to be reviewing loans sales at levels up to 500m.

Table 2

Notable market deals

Parties involvedProperty/Loan name

Country DateLoanamount

Solution implemented

Delancey Plantation Place UK Apr-11 450m

Seeking to take control by striking a dealthrough the distressed debt behind thescheme (loan-to-own) and will injectequity to remedy covenant default.

RBS/ Parella WeinbergREF

Spanish LoanPortfolio

Spain Mar-11 286mSale of distressed Spanish loans with aface value of 286 million. Portfolio is soldwith a discount to face value of 45%.

CIC, Blackstone/Morgan Stanley

Japanese LoanPortfolio

Japan Feb-11 $1.1bnSale at steep discount to face value; paid35 cents to dollar for portfolio ofperforming and non-performing loans

RBS Project Isobel UK Ongoing 1.6bnPlanned sale of loan portfolio; originallyplanned to sell 3bn of loans

Bradford & Bingley Loan book UK Mar-11 500mReconsidering options including splittingassets in sale of loan book

Partners/ Duet/ MetLife Canary Wharf UK Feb-11 107mPartners/ Duet provided Mezzaninefinance. MetLife provided senior loan.

Credit Suisse/ ApolloEuropean loanportfolio

Europe Jan-11 900mSale of loan portfolio with face value ofcirca 2.3bn for less than 900m

Sackville Property/Benson Elliot/ Stanhope

Station Hill,Reading

UK Jan-11 400mConsensual sale of asset withdevelopment value of 400m followingbreach of banking covenant; sold forsignificantly less



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The second approach is for banks to make provisions onknown bad loans. Loans are still retained on their balancesheets, but the bank can make provisions for potentialfuture losses on their loan book down to the level of valuethey expect to recover. The figure is notional and is subjectto change due to wider macro factors which could lead toincreased provisioning in the future, or indeed a favourablereduction.

Based on recent reporting from the Banks we havegenerally seen a reduction in the level of writedowns bankshave been making against problem loans, which would

suggest that most of the problems are now behind thebanks.

However, provisions that banks are making still remainelevated, meaning banks still expect further losses onexisting loans. This will help reduce the future debt fundinggap as those provisions create a notional reduction on thetotal debt outstanding. However, it must be noted that it isthe responsibility of the borrower to cover the debt fundinggap, while with loan provisioning the gap is reduced at theexpense of the lenders.

Growing interest from non-bank lenders

In our previous report, we highlighted the need for morenon-bank lenders, particularly across Europe and AsiaPacific that have traditionally been dominated by banks.

Since then, we have observed a growing appetite frominsurance companies and other funds to invest in loanpositions or to provide senior or mezzanine finance for newlending or refinance opportunities. This will be a welcomerelief given (a) many existing banks are paring back theircommercial real estate loan books; and (b) some of theGerman Pfandbrief Banks, who have been particularlyactive in the past twelve months are reviewing their activity,concerned that they might get over-exposed to commercialreal estate.

The growing interest by insurers is driven in part bySolvency II. This sets out the level of capital required to beset-aside for holding different asset classes. In its currentform the capital charge for commercial mortgages is moreattractive than that for direct real estate ownership. This islikely to shift more insurers into commercial real estatelending, given the lack of credit availability from mosttraditional funding channels. Although this has beencommon practice in the US, it has been virtually non-existent in Europe and Asia Pacific. However, recently wehave started seeing the first cases of interest arising inEurope.

Insurance company Met Life from the US has undertakenits first deal outside the US with a 127m joint refinancingof the Credit Suisse International headquarters in Canary

Wharf in the UK. Allianz Real Estate, also active in the US,is planning on lending to European commercial real estate.AXA has also been active in raising equity from thirdparties, including a number of insurance companies, totarget lending opportunities. It is also providing its ownequity on top of this. In the UK Aviva and Legal andGeneral are known to be eyeing opportunities.


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Section 4: Bridging the gap

The 17% reduction in the absolute global debt funding gapcomes at a time when the amount of available equity in themarket continues to increase, albeit at a slower pace.

Globally we estimate there to be US$403bn of equityavailable for direct investment over the next three years.This is 7% higher than the US$376 we previously reported.It is also double the US$202 debt funding gap over thesame period (Figure 8).

We do see variations at a regional level. In Europe, theamount of equity US$140bn is 19% higher than the debtfunding gap of US$118bn. In Asia Pacific the US$142bn ofavailable equity is nearly 70% higher than the debt fundinggap. In North America we see no debt funding gap asexplained in Box 1.

Of course, some of this capital has global mandates,therefore providing investors with the flexibility to deploycapital where it matters most. There is also some US$46bnincluded within this equity that could also be directedtowards debt positions predominantly in the US and across

multiple regions.

There are problems in matching the debt with the equity aswe have highlighted in our previous two reports. Thisincludes the inability of certain funds to invest in debtpositions. The majority of equity that we monitor is onlyable to invest in direct real estate; however, some of thesefunds do have the ability to invest in debt and will do so ifthe pricing is right. Additionally this year, we have alsotracked funds which will only invest in debt positions.

Figure 8

Debt funding gap and available equity

403

202

140

122

142

118

0

84

0

20

40

60

80

100

120

140

160

0

50

100

150

200

250

300

350

400

450

Global (LHS) Europe North America Asia Pacif ic

US$bnUS$bn

Available equity Debt funding gap


Equity targeting debt solutions

Since the financial crisis started in 2008, we have seen agrowing number of funds raising equity specificallytargeting loan positions, or directly loan origination. In fact85% of the equity available today has been raised sincethe beginning of 2008.

In total we estimate that just over US$36bn has beenraised specifically to target real estate debt. This couldinclude distressed loan positions, refinancing as well asnew finance, including mezzanine lending (Figure 9).

Unsurprisingly the majority of equity raised, which has thepotential to invest in debt positions, is targeted at either theAmericas or across multiple regions. This reflects thedominance of the larger US-based private equity houses.Funds raised to target just Europe or Asia Pacific accountfor a much smaller portion and reflects the limiteddevelopment and availability of such opportunities in thesemarkets.

Figure 9

Equity with potential to target debt solutions

16.2 16.1

3.5

0.6

0

2

4

6

8

10

12

14

16

18

Multi-regional Americas EMEA Asia Pacific

US$bn

Target region



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Unwinding Europes debt funding gap

Globally, Europe has by far the largest debt funding gap. Itis also the region where the debt funding gap is the highestproportion of the available equity (84%).

But, not only is the amount of new equity sufficient, we alsoexpect the debt funding gap to be reduced by provisioningand access to new funding channels.

As we highlighted in the previous section, the debt fundinggap could be reduced from its existing level as banks make

provisions against further losses. Figures are not availableat an aggregate level, however, we do know for examplethat RBS has made provisions of close to 8% of its totaloutstanding loan book according to its 2010 Annual Reportand Accounts.

Of course we expect some variation between countriesdepending on the severity of the debt issue. In ourapproach, we assume a 10% provisioning in the countrieswith a debt funding gap higher than 5% of their investedstock, a 3% provisioning in the countries with a relativedebt funding gap between 1-5% and no provisioning incountries with no debt funding gap. Overall this equates to

around 5% of the total European debt outstanding tocommercial real estate at US$133bn (99bn).

We therefore ran our analysis again with the adjustedoutstanding amounts allowing for the provisioning. Thiswould reduce Europes debt funding gap by 8% fromUS$118bn to US$109bn (Figure 10).

Figure 10

Impact of loan provisioning on European debt fundinggap

0

20

40

60

80

100

120

Debt funding gap Provisions Debt funding gap af terprovisions

US$bn


Insurers increase lending capacity

In our analysis we assume that at the point of refinance,new debt will be available. In Europe we see little diversityin the available funding channel as outlined in Figure 4earlier. The lack of finance is also supported by our recentsurvey of investors. In this survey many Europeaninvestors said that they had found it difficult to obtainfinance on both refinancing existing debt and for newacquisitions (Figure 11). On this basis the capacity toprovide lending at refinance may be constrained.

As we outlined in the previous section, we have seen anumber of new lenders entering the market, notablyinsurance companies. In total we estimate there to bearound US$31bn (24bn) from existing insurers to lendover the next three years. But, since we expect moreinsurers and perhaps pension funds to join the onescurrently looking at this, we estimate that this could go upto US$80bn (60bn).

Our methodology assumes refinancing at a certain LTVand does not explicitly take into account funding. Therefore,the additional US$80bn does not reduce the debt fundinggap in itself, but it does provide additional lending capacity,

and equates to over 8% of the refinancing requirement.

Of course there is the risk that traditional bank lendersmight retrench even more from property lending in theirefforts to limit their real estate exposure. The EuropeanCMBS market has not shown any clear signs of revival yet.Although, an unexpected return would be a favourableadditional upside.

Figure 11

Investors survey: difficulty in obtaining finance byregion

42% 39%

11%

46%

24%11%

58% 61%

89%

54%

76%89%

EMEA Asia Pacific NorthAmerica

EMEA Asia Pacific NorthAmerica

Yes No

New acquisition finance Refinancing of existing debt



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Section 5: Outlook what happens next?

Pressure on banks to delever to step up

We see European banks increasingly pressured to delever.A number of UK banks have pledged to resolve theirproblem (non-core) loans by 2013. Additionally, in Ireland,NAMA, has committed to cut its loan book by 25% by 2013,with the remaining Irish Banks ordered by the Irish CentralBank to dispose of their non-core assets (predominantlythose outside of Ireland) by 2013 also. This will reduce thedebt funding gap further but there is always the risk offlooding the market with low quality assets which depressprices.

Deleveraging pressures will increase as accommodatingmonetary policies begin to unwind. With policy makers inthe US announcing the end of QE2 (quantitative easing),similar policy unwinds can be expected in the UK andacross the rest of Europe as the Bank of England and theECB act to avoid long term competition issues. This willplace more pressure on the banks to step up their hardwork on applying the wide range of different solutions toreduce their real estate exposures.

New lending to remain subdued

In terms of funding, traditional bank lending is expected toremain subdued as supported by our survey of lenders andinvestors. Additionally, given the inactive CMBS market,notably in Europe, it remains to be seen whether corporateand covered bonds will prove to be worthy replacements.The new Basel III capital reserve requirements are likely tofavour property lending through the issuance of coveredbonds rather than CMBS.

In Europe, the German Pfandbrief banks have been some

of the most active lenders to date, with access to cheapcapital from the more secure covered bond market.However, there is some concern over the German banksexposure to real estate, so their continued appetite to lendagainst real estate is not certain going forward.

In Asia Pacific and especially in China we seegovernments introducing further policy measures to reducelending particularly towards the residential sector. However,we have already witnessed a notable increase in propertycorporate bond issuance that has not been seen in eitherEurope or the US. This could be a reaction by corporatesto by-pass policy restraints. Whilst the Asia Pacific region

is largely immune to a debt funding gap, we would highlightthe exposure of developing markets that have seen rapidgrowth in new debt issuance of the risks posed by fallingpricing if lending does not fall to more sustainable levels.

Regulatory reforms to impact future lending

Looking forward, there is a raft of regulatory reforms put inplace as a response to the financial crisis. These have thepotential to impact both the banking sector and investorson the equity side. In our Great Wall of Money report, wehighlighted that many investors held a negative view ofreforms. This sentiment is evident in our survey of lenders,where on balance most lenders have a negative viewtowards reforms, notably Basel III (Figure 12).

With the final impact of these reforms yet to be agreed, it is

not surprising to see such negative views, with manyorganisations still digesting the full impact for themselvesand their clients. We would expect the regulations to haveless of an impact than currently expected as some areas ofregulation get watered down. Indeed for some, regulationcould have a positive impact on lending markets.

Figure 12

Lenders survey: impact of regulatory reforms

9%

60%

31%

80%

82% 100%

40%

69%

20%9%

In general Basel I II AIFM- Directive Solvency II Dodd-Frank Act

Positive Neutral Negative


Regulations to provide more diverse lending base

We expect more non-bank lenders to target loan positionsand enter the market in Europe as a preferred entry routeto real estate. This involves private equity funds but alsoinsurance companies. The latter comes after the proposedSolvency II regulations that impose higher capitalrequirements to insurance companies when owning realestate as opposed to lending to the sector.

Smaller European insurance companies will gradually

follow the larger ones and engage in joint ventures withsmaller banks across Europe to raise the necessary capital.Overall, they will still account for a relatively smaller portionof the market compared to the US.


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Reforms to lending practice

Finally, we might start seeing a gradual reform in loanstructures, probably closer to those in the US that provedto provide more immunity during the last downturn. Longerterm, fixed rate, amortizing loans could be a way to protectagainst a future decrease in property values. Thosestructures would provide more time for values to recoverand also for the involved parties to reach a re-structuringagreement. Furthermore, fixed rate loans would mean thatthe more limited use of fixed rate swaps would allowlenders take action when needed without bearing the huge,

in many cases, costs of unwinding those swaps. Of coursethis could have a negative impact on bank profits due tothe lack of floating to fixed rate swaps and up-frontorigination fees could be significant, but the structuraladvantages for the market in the long term are significant.


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Appendix 1: Interpreting Central Bank data

In estimating the debt funding gap, we rely uponoutstanding debt data reported by individual central banks.This approach is fraught with difficulties. There is a lack ofconsistent and detailed loan data across countries in howthe banks report to the financial authorities.

Some central banks report on lending by banks includingforeign subsidiaries, others break down lending bydomestic and foreign banks in their particular country.There is also the additional complication of subsidiaries,and where their data is reported. For example, Irish Banks,including their UK subsidiaries report to the Irish Centralbank. Those UK subsidiaries regulated by the FinancialServices Authority are also required to report to the Bankof England. Therefore, there is the possibility of somedouble counting at a regional level.

Due to the lack of consistent data we need to reallocatethe debt data we collect to measure the location of thecollateral rather than the origination of the loans that isreported by the central banks (see Box 2 in Section 2 formore details on this). Only the German Pfandbrief marketprovides a detailed breakdown of loans by the location ofthe collateral provided by the Verband DeutscherPfandbriefbanken (VDP) (see www.pfandbrief.de).

Additionally, our analysis is focussed on commercial realestate including offices, retail and industrial properties.Some reporting banks split out residential loans, others donot. Therefore a small proportion of our figures mayinclude residential loans. These do exclude any owneroccupation mortgages or buy-to-let lending.


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Appendix 2: Methodology

Our approach to estimating the debt funding gap is broadlyunchanged on our last report. In Figure 13 we highlight thesix key steps to estimating the debt funding gap based onone single loan.

Figure 13

Estimating the debt funding gap

0

20

40

60

80

100

120

2006 Loan Fall in value2006-11

Asset value2011

Debt available Funding gap2011

US$m

a

b

d

e

f

g

c


In the above example we calculate the gap for a singleloan in the UK as follows:

a) Loan of $100m granted in 2006.b) Value of assets financed total $116m, assuming

an LTV of 86% in 2006.c) Loan due to mature in 2011 (five year term).d) Based on capital value changes1 from the IPD

index and our forecasts, we estimate that valueswill have fallen by 32% ($37m) over 2006-2011.

e) The resulting asset value at 2011 is $79m.f) In 2011 we estimate that debt of $58m will beavailable for refinance based on a 73% LTV.

g) The debt funding gap of $42m is the differencebetween the value of the original loan ($100m) andthe estimated debt available for refinance ($58m).

In reality we are dealing with a multitude of loans,originated in different years and of differing maturities. As ithas been common practice we also need to account for aproportion of loans to be extended. The following describesin more detail how we reached our numbers based on theabove process, step-by-step. Please note some of the

charts relate to a specific country.

1We ignore any impacts from depreciation in our analysis.

Step 1: Calculate outstanding commercial real estatedebt by origination vintage

Our starting point has been to take data for the UK usingDe Montfort Universitys (DMU) lending survey. From thedata we know the originations (in bank lending and CMBS)for each year, and from these we deduct what has maturedbefore 2011. For the purpose of this analysis we are onlyinterested in the sum of originations which equate to theoutstanding amount as at end 2010 (Figure 14).

Figure 14

Loan origination profile

286

16%

17%

13%

24%

23%

7%0

50

100

150

200

250

300

x 2010 2009 2008 2007 2006 2005

bn

Source: De Montfort University; DTZ Research

We assume that the origination of European and Asianloans follows the same pattern as the DMU data, and applythese proportions to the total outstanding debt securedagainst properties in each country taken from our Moneyinto Property database, including the UK for consistency,as at the end of 2010. In this way, we look at the debt

underlying the properties in each market, rather than thecountry in which the loans were originated.

For example, 23% of the outstanding debt in the UKoriginated from 2006. We therefore assume 23% of debtoriginated in this year, in each country. In this way thesum of the originations equals the current outstanding debt.

In the US, we have estimated the loan originations eachyear by applying the loan origination profile from theMortgage Bankers Association to total loans outstanding inthe US as at the end of 2010. As maturities in the US aretraditionally longer, averaging around 10 years, we have

extended the period we cover in the US to 2001. This waywe capture the majority of maturities over the forecastperiod. We assume a similar profile for Canada.


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www.dtz.com 14

Step 2: Estimate refinancing requirements byorigination vintage

The next step is to calculate the refinancing requirementsusing the loan originations calculated in step 1. The DMUstudy provides data on the duration of loans by originationvintage in the UK up to 2009. In order to complete theanalysis to 2013, we have made assumptions on theduration of loans in 2010-2012 (Figure 15).

Figure 15

Loan duration by origination vintage

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1-y 2-y 3-y 4-y 5-y 6-y 7-y 8-y 9-y 10-y

2005, 2006, 2007, 2009

2010, 2011,2012

2008

Source: De Montfort University; DTZ Research

In 2008, we observed a sudden deviation in the duration ofthe loans originated. Data on 2009 loan durationssuggested that this was a temporary movement reflecting ahigh level of loan extensions. We assume future loandurations are more closely aligned with what we have seenhistorically. Applying these loan durations to the loanoriginations we create the future maturity profile (Figure

16).Figure 16

Maturity profile of loans by origination vintage

0

10

20

30

40

50

60

70

80

2011 2012 2013

US$bn

2012

2011

2010

2009

2008

2007

2006

2005


We assume the same profile for CMBS and for loansacross Europe and Asia Pacific. In the US we have useddata on CMBS loans from Bloomberg to create a loanduration series to 2006. For future years we have assumedthe same profile as for 2006. We have followed a similarapproach for Canada.

As outlined previously, we also know that some loans arebeing extended at maturity for an average of two and a half

years and varying in length between one and five years.The value of these loans needs to be pushed into futurematurities in order to estimate the refinancing requirementsand the amount of debt available.

We have assumed that 50% of loans extended are for aperiod of two years, 20% for three years and 10% each fora period of one, four and five years. This gives an averageextension of two and a half years. In 2009 we know two-thirds of loans were extended. We assume a gradualreduction in the proportion of extensions to zero in 2013 ona straight line basis (Figure 17).

We also know from our surveys of investors and lendersthat in 2010 just over 50% of loans were extended. Wealso know that extensions ranged from upwards of twoyears to seven years, with the average around three years.On this basis we did not adjust our current assumptions.

Figure 17

Profile of loan extensions

67%

50%

33%

17% 10%

50%

20%

10% 10%

0%

10%

20%

30%

40%

50%

60%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2011 2012 2013 1-y 2-y 3-y 4-y 5-y

Loans extended Loans matured Extension profi le (RHS)

Source: De Montfort University, DTZ Research

Allowing for extensions, we see an adjustment to thematurity profile. This is best shown by taking the exampleof the single loan we highlighted at the start of this report.In this example, the first four steps of the process remainthe same (Figure 18). Thereafter we see some smallchanges.


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www.dtz.com 15

e) By extending the loan by a period of two yearsfrom 2011 to 2013, we benefit from a further upliftin capital values.

f) In this case values improve by 3% to $82m.g) With a marginally higher LTV of 75% we can

borrow more ($61m).h) The resulting debt funding gap is marginally lower

(-7%) at $39m.

Figure 18

Estimating the debt funding gap with extensions

0

20

40

60

80

100

120

2006 Loan Fall in value2006-11

Asset value2013

Debt available2013

Funding gap2013

US$m

a

b

c

d

e

f g

h


The resulting maturity profile is outlined in Figure 19 andclearly shows the shift in maturity to later years.

Figure 19

Maturity profile before and after extensions

0

10

20

30

40

50

60

70

80

90

100

US$bn

20122011

2010

2009

2008

2007

2006

2005

2011 2012 2013

Beforeextensions

Afterextensions

Beforeextensions

Afterextensions

Beforeextensions

Afterextensions


Step 3: Estimate original property values byorigination vintage

Based on historic maximum loan to value ratios (LTVs) atthe all property level from the DMU survey, we cancalculate the value of the underlying assets in each year(Figure 20). We have assumed LTVs are similar in mostmarkets in Europe and made assumptions from localoffices for markets in the Asia Pacific region. In the US, wehave made adjustments from CMBS loan data fromBloomberg. In Canada we have adjusted LTVs based ondiscussions with our local office.

Figure 20

Original property values by origination vintage

87% 86% 84%

72% 72% 72% 73%74% 75%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

20

40

60

80

100

120

140

160

180

2005 2006 2007 2008 2009 2010 2011 2012 2013

LTVUS$bn

Loan origination Implied equity Max LTV (RHS)


Step 4: Estimate future property values to berefinanced

Applying capital value changes to each of the assets

underlying the loans by vintage and the known maturityprofiles we can calculate the future value of the underlyingassets. For the UK we have applied capital value changesfrom IPD as this provides a better proxy for the market as awhole. In continental Europe and Asia Pacific, IPDscoverage and history is not as extensive, therefore wehave derived an All Property series based on our ownprime capital values for each country. For both series weapply our own forecasts, which provide us with the value ofassets to be refinanced in future years.

In the US we have used a capital value series from theMIT/ NCREIF transaction index, which provides a better

proxy for the overall market. To this we have applied ourown forecasts for prime capital values going forward. InCanada we used IPD data historically with our forecast ofprime capital values going forward.


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www.dtz.com 16

Step 5: Estimate available debt for future refinancingbased on future LTVs

Taking the value of assets for refinance (step 4), andapplying our estimates for LTVs, we can calculate thevalue of debt that we estimate to be available for refinance(Figure 21). From the 2009 DMU survey we know theaverage LTV was at 72%. In future years we haveassumed a gradual recovery to 75% in Europe and the US.In Asia Pacific we assume a recovery to 70%.

Figure 21

Estimating the value of debt available in the UK

53

76

98

39

56

73

72%

73%

74%

75%

76%

010

20

30

40

50

60

70

80

90

100

2011 2012 2013

LTVUS$bn

Value of assets for refinance Debt available max % refinancing LTV (RHS)


Step 6: Calculate debt funding gap between existingdebt refinancing requirements and debt available

The final step is to calculate the debt funding gap. We dothis for each individual year by deducting the value of debtavailable (step 5) from the value of loans for refinance ineach year (step 2). The sum of all the positive valuesleaves the total value of the debt funding gap (Figure 22).

Figure 22

UK debt funding gap

52

71

87

39

56

73

13

15

14

0

10

20

30

40

50

60

70

80

90

2011 2012 2013

US$bn

Refinancing requirements (Step 2) Debt available Debt funding gap

2011 2012 2013



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DisclaimerThis report should not be relied upon as a basis for entering into transactions withoutseeking specific, qualified, professional advice. Whilst facts have been rigorouslychecked, DTZ can take no responsibility for any damage or loss suffered as a result ofany inadvertent inaccuracy within this report. Information contained herein should not,in whole or part, be published, reproduced or referred to without prior approval. Any

such reproduction should be credited to DTZ.

DTZ 2011

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