DTZ

05 May, 2011

The global debt funding gap^[1] is estimated to total US$202bn over the next three years (2011-2013) according to new research from DTZ. This represents a 17% reduction on the US$245bn estimated in November 2010^[2]. The latest report shows that despite the overall reduction in the global figure there are significant variations at a regional level. Both Europe and North America have seen a reduction in their debt funding gaps. In the United States, the funding gap is now estimated to be zero over 2011-2013, down from US$49bn. However, as the US$49bn was only 1% of invested stock, this change is not as dramatic as it appears given the strong capital value growth in the Q4 2010 and a decline in outstanding debt. In Europe, the debt funding gap decrease is a moderate reduction of US$8bn to US$118bn. In contrast, Asia Pacific’s debt funding gap increased US$14bn to US$84bn, with the vast majority of the increase attributable to Japan.

At a country level, Japan has the largest absolute debt funding gap standing at US$84bn, a US$14bn increase from the previous report. This is the result of a greater amount of debt to commercial real estate (up 10% since the end of 2009), and a decrease in forecasted capital values following the 2011 earthquake and subsequent tsunami. The UK debt funding gap has decreased by 22% to US$42bn. Other European markets continue to have significant debt funding gaps including Spain, down by 14% to US$28bn.

In broad terms, the debt funding gap is matched by new equity raised for investment in commercial real estate. DTZ Research estimates that US$403bn of new equity capital is available for investment in commercial real estate markets globally during the next three years . This is nearly double the US$ 202bn debt funding gap estimated for the same period. As noted in previous reports, difficulties remain in respect of a direct match between debt and equity available including the inability of some funds to invest in debt positions. However, there are a growing number of funds that have been raising equity specifically to target real estate debt.

A number of alternative solutions to bridge the debt funding gap have been implemented in recent months, as banks increasingly look to delever. In addition to ‘extend and amend’ practices, loan sales have become an increasingly popular way for banks to reduce their lending exposures. This approach has been widespread in the US, but is becoming more prevalent in Europe and Japan.

Another approach is for banks to make provisions on known bad loans – taking potential future losses down to the level of the value expected to be recovered. These provisions can help reduce the debt funding gap by decreasing the notional amount of debt outstanding.

Nigel Almond, Associate Director of Forecasting & Strategy at DTZ and author of the report comments: “Our analysis shows that Europe continues to have the largest debt funding gap. However, it is also the region with the lowest ratio of debt funding gap to available equity. We anticipate that banks will make provisions against further losses. This is estimated to reduce the region’s funding gap by 8%, from US$118bn to US$109bn.”

Furthermore, since the previous report, there has been a marked increase in non-bank lender activity. In particular, insurance companies focusing on new lending and funds seeking to invest in loan positions or to provide mezzanine finance. The former has been driven in part by Solvency II, incentivising European insurers more towards real estate lending.

Based on recent announcement and our expectation for new entrants, we estimate that existing and new insurance companies and pension funds entering the European lending market will provide US$80bn of lending capacity. This brings badly needed funding capacity and more diverse funding channels to the sector. In fact, the US$80bn in additional funding equals over 8% of the refinancing requirement over the next three years.

Hans Vrensen, Global Head of DTZ Research, said: “Looking forward there is increasing pressure for banks to delever. In Ireland and the UK for example, a number of large banks have formally committed to reduce their problem loan or non-core loan portfolios by 2013. Banks will be under additional pressure to find solutions to reduce their overall real estate loan exposure, as central banks are now looking to unwind monetary and liquidity support policies. This is further enhanced by pending regulatory changes, such as Basel III.”

^[1] This gap is defined as the difference between the existing debt balance secured by commercial property as it matures, and the debt available to replace it

^[2] See DTZ Insight Global Debt Funding Gap report 24 November 2010

^[3] See also DTZ Insight Great Wall of Money report 10 March 2011