Commercial Real Estate Loan Requirements

From our perspective, the attractiveness of the investment category should remain unparalleled beyond the end of the present year. Income from CRE' operations in Europe is made up of charges levied on the borrower at the time of lending and redemption and interest on loan payments made each quarter. Looking only at the interest rate components, the spreads for CRE credits have performed significantly better than for public sector bonds, making them very lucrative in both terms of value and exposure.

The performance of SROs has always been better than that of public sector corporates with a similar credit spreads as shown in Figure 1 below. A and BBB valued GBP Corporates 3-5 years assets swing spread) and Cass Business School'UK Commercial Real Estate Lending Report, December 2007'.

In addition, the yields of CRE credits are competitive in comparison to foreign real estate investment. According to estimates released by the Investment Property Forum, an organization of British CRE sector members, the overall annual yield for British commercial real estate over the next five years is 4.8%, including rent.

In particular, this applies if one takes into account both the high levels of guaranteed earnings and the downward protective effect of the credits. Whilst the development of the CRE market will differ from country to country, the general assessment of the real estate market in Europe is characterised by value and rent rates are unlikely to increase as rapidly over the next five years as they have in the last five.

Downward credit protects the investment class's appeal compared to real estate. The loan-to-value (LTV) figures on the CRE lending markets in Europe have declined since the 2007/08 GFC and are now at a lower low since. In addition, the commercial banking sector provided about 95% of all Europe's CRE credits to the GFC.

Banking rivalry led to ever more aggressively competitive credit granting practice; LTV ratings consistently surpassed 80% of protection value and fiscal coupons were either diluted or completely sold. At the end of the lifecycle, the outcome of these hostile activities was catastrophic - banking loan exposures to CRE exposures that were excessive compared to the historic mean worsened, and the NPL relationship rose to historic high values, as the following graph shows.

As a consequence, the banking sector was obliged to reduce its credit business. Consequently, the open up of the markets to cover its financing needs was inevitable, and a new type of non-bank lender, such as public sector creditors, insurance companies and retirement fund providers, came into effect, discovering a singular business proposition that was previously largely non-available.

Rather than being repetitive, this shift is more of a structure. While the NPL problem is a cycle problem that is being tackled, at the organisational levels the changes are being pushed by banking supervisory requirements for higher equity, in particular for certain kinds of activity such as CRE Credit. Possibility of granting credit outside the European CRE Credit Institution began in the United Kingdom when UK credit institutions launched NPL disposal or other treatment schemes.

Opportunities then spread across Europe as banking institutions in other jurisdictions implemented similar programs and prudential requirements made CRE loans less appealing. Opportunities are now Europe-wide, with Ireland, Spain and the Netherlands becoming the most lucrative CRE loan investment market. Besides overall diversity, a pan-European view provides significant advantages; CRE is still below the last top in most EU economies.

There is no assurance that the levels will not drop below the lows of the last 20 years, but we believe that the downward safety of CRE credits should reassure people. Restructuring changes in the CRE credit markets have given investor the ability to generate compelling, secure yields from an investment category that offers significant downward risk shelter.

Credit CRE offers a uniquely compelling and very competitive risk-return replacement or complement to other types of strategic interest rate liabilities.