Real estate debt: Spain & Italy show opposite attractions

Carlos Pla and Stefano Questa at Hayfin spoke to GRI Hub about NPLs and real estate financing in Spain and Italy.

May 2, 2019Real Estate
Spain and Italy present very different opportunities when it comes to real estate debt, in the eyes of Hayfin Capital Management, a UK-headquartered, Europe-wide private debt firm. Hayfin does not operate a dedicated real estate lending fund like, say, PGIM Real Estate or M&G Real Estate. However, Hayfin will undertake real estate lending and debt transactions “if it makes sense to get involved,” according to managing director Carlos Pla, who leads the firm’s Special Opportunities strategy.

Pla provides an overview of Hayfin’s involvement in real estate debt in Southern Europe: “In Spain, we’ve been very active since late 2013, but the bulk of what we’ve done has been around buying debt through secondary transactions - non-performing loans (NPLs) or stressed loans - as opposed to financing new deals. In Italy, the situation has actually been the other way round. Because of the more challenging situation of Italy’s banking sector, we have found it quite attractive to do some primary real estate financing.”

Spanish NPL run

Around 90% of the NPLs purchased by Hayfin in Spain have come through Sareb, the bad bank founded in 2012 by the Spanish government, and most of those NPLs are backed by residential assets. “Typically, they are developer loans that got into trouble at the beginning of the crisis,” explains Pla. “The developer had finished, or was close to finishing, a residential development, but then the crisis came and they got stuck with units they couldn’t sell.”

Regular dialogue and building trust with Sareb has been key for Hayfin in sourcing its deals, as well as having a local presence. “Real estate is a very localised asset class and takes significant effort,” comments Pla. “We’ve seen a lot of investors driving transactions from a desk in London or New York and then realising it’s harder work than they initially thought.” 

As well as a Spanish offices, Hayfin maintains a network of relationships with local advisors - lawyers, valuers, and loan and asset servicers. “We consider them as partners, given the amount of work we do together and the relevance of that work for our investments,” says Pla. Valuers provide an idea of the value of the collateral before investing in an NPL - vital in a market with limited transparency on price data and transaction history - while lawyers help transform an NPL and the assets against which it was secured into a repayment. Lawyers need experience as much as expertise, and that comes down to the individual, continues Pla: “Lawyers must have experience in enforcing, in court, because timing is critical to investments. There’s a big difference in the speed that a court is moving depending on the location. Understanding that dynamic is very important.”

Pla estimates that once Hayfin has bought an NPL, it might take on average two to three years to begin realising value from the asset, depending on the situation: “So right now we are in the process of monetising those NPL portfolios which we bought in 2015/2016.”

Sareb tightens NPL pipeline

Sareb, the principal source of NPL opportunities for Hayfin in Spain, released an update on 28 March 2019 stating that over the last six years, it had reduced its loan portfolio by 44%. Going forward, Sareb is focusing its strategy on real estate development and on speeding up the process to convert its portfolio of non-performing loans into properties in order to preserve their financial value. Sareb executive chairman Jaime Echegoyen explained: “2018 was a very demanding year due to tough competition in the wholesale market, with levels of discount that the company cannot and should not agree to. During the coming years we will continue to prioritise the conversion of loans into properties, assets that are much more liquid and easier to sell, and that will allow us to benefit from the consolidation of the real estate cycle”, he added.

Despite Sareb’s shift in strategic focus, Pla comments that Spain’s bad bank will remain a large and active vendor of NPLs. However, the opportunities are getting more difficult: “There has been a lot of transaction activity in the market and I would say that while there’s still opportunity, you have to be a bit more cautious and selective. The buying environment has changed.”

Why not NPLs in Italy?

Stefano Questa, managing director at Hayfin, who works on special opportunities alongside Pla as well as on direct lending, says that in Italy, “NPLs became very expensive, very quickly, in our view. We’ve participated in processes and auctions and discussions with sellers, but we’ve typically found that our valuations haven’t matched market pricing.” 

From an NPL perspective, explains Questa, Italy became active later in the cycle compared to countries like Spain, Germany, Ireland and the UK: “By the time NPLs started trading in Italy, which was really in 2015, you had a lot of dedicated capital chasing NPLs, Europe-wide and world-wide. Whereas NPLs in the early part of the decade were mostly invested in by multi-strategy funds, by the time the Italian opportunity materialised, you had a lot of large monoline funds set up to acquire NPLs, increasing demand for these credits.”

Investors may also have been encouraged to enter the Italian market by legal reforms, enacted by the previous government and designed to make Italy’s legal system more creditor-friendly. However, Questa, who previously worked on the acquisition and management of several Italian NPL portfolios during his previous tenures at Goldman Sachs and TPG, suggests that “it is possible that buyers may have become too optimistic regarding recovery timelines and the impact of the legal reforms, as well as the real-life difficulties of resolving the positions.” 

In a way that’s “perhaps even more pronounced” than in Spain, says Questa, recovery timelines in Italy vary dramatically between different courts: “The reality is that changes in the legal framework may have little to no impact as to how quickly the workout of a specific NPL will make its way through a specific court.” 

Questa reckons that the value of underlying collateral in Italian NPLs may also have been overestimated. “Whereas in Spain, the overwhelming majority of NPLs are secured against residential property, in Italy, the majority of NPLs were extended to SMEs, most of which have now effectively folded. And oftentimes they are ‘seasoned’ loans, meaning that the underlying companies may have become insolvent before the 2008/09 crisis, such as in the early 2000s, or in some cases even in the 1990s. So you’ve got companies that have gone out of business quite a long time ago, and your recovery will be whatever unencumbered or partially unencumbered collateral there might be.”

The ultimate recovery for Italian NPLs will tend to be commercial real estate, such as factories, warehouses and other industrial property, and Questa wonders how much value the assets will have. “Many of these companies that went under were producing things that are no longer typically made in Italy, or Western Europe; with the Italian economy having relatively successfully pivoted away from low-end manufacturing and textiles into luxury and specialised manufacturing, it will be interesting to see how many of the assets underlying the NPL portfolios can be repurposed once the new buyers take possession.”

Lending - the flipside of NPLs

“The flipside of the NPL situation is that we’ve had more luck in finding opportunities to lend to real estate in Italy,” says Questa, “and that’s because the Italian banking system is still facing very significant challenges. Italy’s banks find it hard to lend, particularly in size and complexity, and in many cases they are still working through capital constraints and balance sheet reduction.”

A series of capital increases in 2016 and 2017 helped unlock things a little bit, says Questa, as it allowed some NPLs to be sold. “However, Italy is still far away from the recovery that the Spanish banking system has seen, because the banks still have a very significant NPL drag and are operating in a less buoyant macroeconomic environment.”

Hayfin takes an opportunistic approach to the real estate debt market, entering situations “that have a risk profile that is still very attractive in our view, but is slightly beyond where the more vanilla lenders would fund it, and therefore makes the absolute return attractive to our investors.” Where those opportunities are to be found, continues Questa, is a function of the banking market. “Italy right now is a market with little depth, diminished reliability (partially because of recent political uncertainty) or appetite for complexity, and where overall banks are aiming to shrink exposure. It clearly creates opportunities. In Spain, it is less so, as the banking system is functioning better.”

History lesson

Because of the late phase of the market cycle, Hayfin is focusing on high-quality assets. “We’re happy to take calculated risk around liquidity and size, but what we really want is high-quality assets,” says Questa, who mentions by way of example a prime high street retail asset in Milan. “It’s one of the highest-quality retail properties in all of Italy. It’s a ‘last-line-of-defence’ asset, and our debt is covered in more severe yield expansion scenarios than have been observed since reliable records began.”

“Typically, these kinds of assets don’t depreciate as much in a downturn, and they rebound more quickly in a recovery,” says Questa. “History teaches us that.”

Real estate lending and investment will be discussed further at Deutsche GRI 2019 on 8-9 May in Frankfurt, at British & Irish GRI 2019 on 15-16 May in London, and at Europe GRI 2019 in Paris on 11-12 September.

Read more in GRI Hub’s series on real estate debt: