24 November, 2010
- Europe has the biggest debt funding gap compared to Asia Pacific and the US with many small European markets (e.g. Ireland) showing significant relative gaps
- Japan has largest absolute debt funding gap at US$70bn amongst individual countries, but no other countries in Asia Pacific have any significant gaps
- Sufficient new equity capital has been raised to bridge the global debt funding gap, but obstacles have prevented resolution to date
- Banks are progressing from ‘extend and pretend’ to ‘extend and amend’
- Increase in non-bank lenders required to diversify funding channels
DTZ Research estimates that the global debt funding gap totals US$245bn over the next three years (2011-2013). 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. The debt funding gap continues to be the biggest challenge in many international property markets. The report shows that Europe has the greatest exposure, with 51% of the debt funding gap (US$126bn), followed by Asia Pacific with 29% (US$70bn) and the US with 20% (US$49bn).
Among individual countries, the largest absolute debt funding gap is in Japan (US$70bn), followed by the UK (US$54bn), the US (US$49bn) and Spain (US$33bn). The remaining markets, including Germany and France, have absolute debt funding gaps below US$10bn. Relative to the size of their markets, many smaller European markets have significant funding gaps, especially Ireland.
An additional factor influencing the debt funding gap is that secondary properties are likely facing a much higher refinancing risk than prime properties. Based on limited data, yields on secondary assets have widened more relative to prime assets. Given current risk aversion, investors and lenders are targeting prime properties with demand for secondary assets remaining very low. As a result, values on secondary assets have not recovered as quickly as prime, leaving these assets more exposed. The risk of secondary properties’ cash flows being impacted by insufficient capital expenditure is a further risk. This could pose a double threat to secondary quality collateral and the associated loans.
New equity raised could be a significant part of the solution for the debt funding gap. DTZ Research estimates that US$376bn of new equity capital is available for investment in commercial real estate markets globally during the next three years. This is more than 1.5 times the estimated global debt funding gap. However, a number of obstacles remain that prevent a direct and short term match between the debt funding gap and newly available equity. For example, many investors do not have the ability to buy loans. In addition, loans have not been priced attractively enough to meet the required returns of investors.
Nigel Almond, Associate Director of Forecasting & Strategy at DTZ and author of the report comments: “Our research highlights the extent of the debt funding gap and the exposure of individual countries, especially in Europe. This is primarily driven by the divergence in loan maturity market conventions. In the US, loan maturities are on average 10 years, which has left the US market relatively insulated against the capital value falls of recent years. In contrast, loan maturities in Europe and Japan are on average five and three years, respectively. Therefore, these markets have proven to be far more exposed to the recent value declines. Furthermore, scheduled amortisation and fixed rates are offering the US a significant advantage in tackling the funding gap.”
Hans Vrensen, Global Head of DTZ Research, said: “Recently, we have seen an increase in government and other activity to start to address the debt funding gap with an increasing array of innovative solutions. Banks have been moving on from extend and pretend to extend and amend. Loan maturity extensions are progressively being replaced by an extension coupled with an amendment of the base loan terms and covenant. Banks are also forcing full cash trapping to ensure any excess revenue from a secured property is used for amortisation of the loan.
“Although banks and borrowers have not been forced to seek more dramatic solutions to the debt funding gap, a number of imminent changes look set to increase the pressure. As governments focus on reducing their sovereign debt, a potential unwinding of accommodating fiscal and monetary policies will put more pressure on banks to deal with their most problematic loan positions. New regulatory changes will also increase pressure for equity investors. As a result, we expect that market participants will continue to implement a range of innovative solutions in a prolonged messy workout process.”