A helping hand

Mezzanines, leasing, funds – such forms and sources of finance are not going to replace bank loans, but they may make them easier to obtain. Although these methods may be more expensive, interest in them is clearly rising

Emil Górecki

When it comes to real estate, nothing can replace a commercial loan collateralized by a mortgage – so claim old hands in the trade. In the light of the financial sector’s global troubles, however, most banks have put a stop on new loans and now grant them only to a narrow band of trusted clients. Perhaps it is time to find another solution? According to Piotr Górecki, associate director in the capital markets department of Knight Frank: “Of course I’ve noticed the growing interest of larger developers in ways of funding than other credit. They cannot escape the need for loans; but instead can adopt strategies to make it easier to obtain them. If a bank requires a 30-40 pct own contribution and a developer doesn’t have such financial resources, they can top them up by means of a subordinated mezzanine fund or through the resources of co-investors, which can be in the form of various kinds of funds.”

The bridge loan option

Difficulties in obtaining credit have increased the demand for mezzanine funding, a market niche that banks are starting to move into, but which is much more risky and expensive. Unfortunately this is not an option open to insolvent or new companies. “This form of funding has been known about for a long time, but it has only become more popular since H2 2008. There are a number of institutions offering mezzanine finance in Poland, but because there are no major barriers to international capital flows, the possibilities of acquiring such funding are much wider. You can apply for them not only in Europe and North America but also in the Middle East. Yet mezzanine funds are two or three times more expensive than development loans, and the AER interest rates offered nowadays exceed 20 pct,” says Piotr Górecki.

For granting development loans, banks require projects to have a certain amount of their scheme pre-let to allow the developer to service the loan. As a rule, in the case of traditional funding this loan-to-value ratio (LTV) should be at a minimal level. In order to top up own contribution capital with a mezzanine loan, the development should fulfil these conditions with an additional safety margin. “We have been observing increased interest in our fund for the last few months. A number of developers have come forward: the large and the small, from all market sectors. Their enquiries concern projects of different profiles: from the finalization of land purchase transactions to supporting construction completion,” claims Marcin Prusaczyk, a partner at Griffin Advisors, which last year introduced the first mezzanine fund to the Polish market – Griffin Property Finance 
– focused on the real estate market.

So can mezzanine finance really replace credit? As Marcin Prusaczyk suggests, for a short period and in special situations – yes, it can. The GPF fund granted a few loans with bridge financing qualities in H2 2008. “These loans have a quasi-bank funding character, because firstly they are collateralized by a mortgage at a loan-to-value ratio we are comfortable with. But of course, the borrowing costs in the case of such loans are much higher,” claims Marcin Prusaczyk.

GPF has already used up all its funds – a total of EUR 250 mln. Talks are pending as to the acquisition of new funds from investors. “In principle, our fund has not changed its expectations over returns on investment. But because of a general fall in the profitability of development projects, we are currently expecting a higher share in profits in order to obtain the estimated rate of return,” says Marcin Prusaczyk. So far, the share in profits was at the level of 20-30 pct depending on the projects’ profitability and the fund’s level of engagement. At the moment this share would have to exceed 30 pct in order to reach the estimated rate of return and compensate for the higher investment risk. However, because of the very restricted possibilities for bank funding, few projects qualify for mezzanine funding. However, since last year, Griffin Advisors Fund has had competition in the form of the Catella Property Group, which until now has not concluded any transactions in Poland. Moreover BRE Bank also currently offers mezzanine funding.

Oriental capital on tap

Another method for obtaining essential capital is through investment funds, which arrange for purchases of real estate in forward transactions where they negotiate transaction terms during the construction stage and distribute the resources as construction progresses. Until now, forward transactions/purchases were usually connected with the purchase of a portfolio of real estate, where at least one property was under construction; however, it is possible to conduct a forward funding deal before any construction has taken place. In the current conditions this can be regarded as a form of new project funding. “An increased interest from investment funds is already noticeable, but their financial expectations are different from those of potential sellers. These differences can amount to as much as 100-150 basic points in yields. The number of investment projects could pose something of a restriction in future, as many will not be launched at all. At the moment we are anticipating the first transactions that will establish a new level of yields,” reveals Piotr Górecki.

The current market conditions are favourable to different kinds of opportunity funds, which expect a higher return on their investment in exchange for a higher investment risk. A large number of these funds come from Great Britain, the USA and Germany. However, as in the case of petrodollars from the Middle East, there are many interested parties in countries from different parts of the world. “We remain attractive. Warsaw as an investment location is nowadays listed next to cities such as London and Paris,” asserts Piotr Górecki.

Rent your office

Institutions offering real estate leasing are also noting an increased interest in their services. However, the structure of these services excludes or restricts to a large extent the functionality of this form of real estate funding on the investment market and may at the most only help developers or investors with their liquidity. “This is connected with the transfer of property rights to the lessor and the life of such contracts. They are more often for 10 years, which is an unacceptable period for the typical developer. But the advantage of this form of capital acquisition is the fact that its cost is not much higher than that of bank loans,” says Piotr Górecki.

According to research carried out by the Polish Leasing Association (PLA), ING Leasing was the leader on the Polish market with regards to the number and the value of real estate leasing contracts. The company finalized 160 real estate leasing contracts with a total net value of PLN 1.373 bln. The other main players in Poland include: Bankowy Fundusz Leasingowy, BGŻ Leasing, BRE Leasing, Fortis Lease Polska, Millennium Leasing, Pekao Leasing and Raiffeisen Leasing Polska. According to the PLA, these companies and the smaller players on the market 
have a total worth of PLN 2.868 bln. However, this list omits a number of entities offering real estate leasing services, since PLA’s data does not include, among others, LHI Leasing, which left the organization last year. “At the moment, a number of developers are forced to keep projects in their portfolio for a longer period of time, despite the fact that they had developed them in order to make quick sales and profits. Sales transactions of such properties free up capital for developers and allow them to invest it in other enterprises. However, these properties must fulfil certain conditions so that the transaction can take place. This includes a good location, a high standard of construction and design or a suitable tenant mix and lease period,” believes Robert Mandżunowski, managing director at LHI Leasing.

Developers can liquidate in a similar way the frozen capital in projects that are not yet completed. Conditional sales and lease contracts are signed in such cases. “We are not willing to undertake the speculative risk of a developer’s project,” explains Robert Mandżunowski. “The job is then to give guarantees on the basis of concluded lease contracts and the appropriate income level, which facilitates the payment of leasing instalments.”

According to international standards of bookkeeping, operational leasing contracts are the most popular in transactions connected with real estate, where after the expiry of a contract a lessee is entitled to purchase a property at a price established, among other factors, on the basis of the length of the contract. Although the interest in this financial instrument is on the increase, LHI Leasing’s managing director does not expect the competition to intensify, because one pre-requisite for this type of transaction is an experienced team of people. ν