The sixth issue of the FAP Mezzanine Report has just been published, and it provides very useful insight into the financing practices of capital providers active in the market for subordinate financing. While acknowledging that growth is still lagging earlier market expectations, and that the optimism of last year has somewhat evaporated, the report nonetheless highlights the critical role that mezzanine finance is playing in keeping the German market lubricated during the COVID crisis.
The number of institutional providers is still growing – The FAP Report identifies at least 155 providers, nine more than in 2019. Of these, 53 participated in the compilation of the report, with the responding participants providing €6.9bn of mezzanine capital during the reporting period, supporting the financing of more than €40bn of actual developments. This is more than last year’s €5.8bn.
The positive effect of these increasing numbers of capital providers, says the report, has been to help stabilize the market for financing German projects and existing property.
The study shows that, where last year a quarter of finance providers were focused on project developments, this year only 18% rely on developments alone. Clearly the boundaries between portfolio financing and project development are becoming increasingly blurred - for example, when repositioning portfolio properties by optimising the tenant structure and related construction measures.
The top locations are showing an emerging two-track structure. Whereas last year, only 10% financed exclusively in A-cities, that figure is now 32%. At the same time, the proportion of those who would no longer exclude commitments in C-cities is rising. This year it is 44%, up from last year’s 26%.
The average overall interest rate return on mezzanine financing is 10%, with the interest rate range now broadening from 5% to 18%, demonstrating the broad risk spectrum serviced by mezzanine capital.Last year it ranged only from 5% to 14%. Financing on existing property by institutional investors for properties with good cash flow in prime locations is stillpossible at 5% on subordinated capital. On the other hand, loan funds in particular state that they have been providing capital for properties difficult to finance owing to the coronavirus crisis (e.g. hotels). In such case, expected returns are then significantly above 10%.
The broad regional spread of financing continues to decline, with institutional investors showing increasing caution. Only 23% are still financing properties across the whole of Germany, whereas the share prepared to finance anywhere in the country last year was over 40%.
Hardest hit, though, is the general sense of optimism among finance providers. Whereas 64% of the respondents in 2019 still said they expected the market to develop positively in the next twelve to 18 months, this figure has now fallen to just 4%. Meanwhile, 58% of those surveyed expect a slight downward trend. Last year, that proportion was negligible at 2%.
There has also been a shift in asset preferences, with offices falling somewhat out of favour since March. Even micro-apartments and small offices have failed to maintain their high rating among mezzanine lenders, although residential is still highly valued by all respondents. The study’s authors note a tendency for lenders to reduce the number of actual deals, but compensate for that by a higher lending volume per investment. For example, the share of mezzanine financing on deals over €30m was higher than ever, at 28%. Last year it was 24%.
According to the makers of the study, the aim of many mezzanine lenders is to reduce the number of deals and then compensate for this by increasing the volume per investment. The share of financing for tranches of over €30 million, for example, is higher than ever at 28%. Last year it was 24%.
Loan financing terms are also getting longer, partly to do with improved cost-benefit relationships, conclude the researchers. This number is being boosted by the increasing number of institutional capital providers. Hence the clearly visible shift in the maturity curve, which conversely means less availability of financing of below twelve months. The longer financing periods are also being encouraged by the current zero interest rate level.
