Property developers: Dangers of relying on vulture fund recovery
SINCE 2010 most big Irish developers have been out of action. Having fallen under Nama’s spell they existed in a twilight zone where they were allowed neither to perish nor to be let loose again .
Since 2014, however, the spell is weakening and some of the big names behind the Irish bubble are lurching back into action. The backdrop to this is the remarkable recovery of Irish commercial real estate — offices, retail units and development land have been selling like hot cakes — in large part driven by vulture funds.
While many of us will baulk at the return of our high-flying builders, we should also remember that what gave the developers the capacity to wreak such damage on our cities and towns (and eventually our economy as a whole) was the massive increase in international credit flowing into Ireland during the boom. With the arrival of the global funds, international finance has found a new route into Irish property — once more potentially posing systemic risks to financial and property markets.
To understand the dangers the renaissance of commercial property poses, we need to understand more fully just how it has come about. Last year transactions in commercial property in Ireland surpassed levels last seen at the height of the boom, hitting more than €4.6bn. But this figure was itself dwarfed by the size of the loan sales market, which soared to €21bn. The hottest sector is office property, and it’s not hard to see why.
Following the crash prices in the office sector collapsed by up to 67%. While office rents initially dropped by 45% and vacancy shot up to 23%, more recently strong office take-up (2.3m sq ft in 2014) and minuscule new supply have pushed rents back up rapidly. Rental growth has been strong, rising from a trough of €27 per sq ft in 2011 to €35 per sq ft in 2013, and increasing by a further 30% to €45 in 2014. Many analysts believe this trend will continue and may hit €60 per sq ft for prime office space within a few years.
At the same time, huge volumes of distressed debt linked to real estate has been offloaded by a range of financial institutions. The foreign lenders led the way with Danske, Ulster Bank, and Lloyds all rushing to reduce their exposure to commercial property in Ireland. But these were quickly followed and surpassed by the two quasi-public “wind-down agencies”. Out of €96.7bn of commercial property loan sales in Europe in 2013 and 2014, an incredible €36bn related to assets sold by Nama and IBRC. This is an astonishing figure for such a tiny country.
The many financial institutions eager to get rid of real estate debt have been selling at big discounts.
IBRC was operating in the context of liquidation while Nama has been under pressure (partially from the troika and partially from the Government) to meet stringent debt redemption targets. With office take-up and rents rising and essentially no new supply coming on stream, investment in office property became hugely attractive in 2014. As one property insider told me, “the stats were jumping off the page”. However, with our own domestic banking sector still in a state of paralysis and many developers bankrupt or in Nama, there were few Irish players in a position to take advantage of the open goal. Enter the vulture funds. Global private equity firms, hedge funds, and property companies with huge financial fire power have invested heavily in distressed real estate debt, putting them at the centre of a property market once dominated by homegrown investors.
There are essentially two types of new international actor on the scene:
- On the one hand, the private equity firms and hedge funds who focus on buying bad debt at big discounts. They can then restructure loans, take over underlying property assets, flip or a combination of all the above. They have a very short term focus. The biggest in Irish terms is Lone Star Capital, but there are many others which should be household names including Blackstone, Oaktree Capital, Starwood Capital, and King Street Capital.
- On the other hand, international property development companies buy both distressed debt and direct properties and focus on more long-term investments, often undertaking very large new developments. The big names here are Hines and Kennedy Wilson. The former is a Texas-based family-owned firm which bought up more than €1bn worth of property in recent years and is set to develop the huge Cherrywood development in Dublin 18. The latter is the LA-based company behind the Capital Docks and Clancy Quay developments.
It’s important to remember that this isn’t just a case of “the market” sorting itself out. The Government and public agencies have played a crucial role here. Nama has stated that it “is keen to attract international capital interested in acquiring loans or property assets”. The Department of Finance has also been busy meeting with the so-called vulture funds. Needless to say our tax system is also a big draw.
To be honest, it makes little difference to me if the city I call home is owned by a financial fund or Irish developer. But there are dangers here we need to consider very carefully:
- Firstly, international firms may escape Irish regulation. We have seen this where funds buy mortgage debt but are not subject to the terms of the Government’s code of conduct around arrears.
- Second of all, international funds are financial institutions without a “retail presence” in Ireland. They have no long-term interest in developing client relationships or a positive brand. In short, they can squeeze debtors as hard as they like.
- The main concern is the third one, and it relates to what we might call the “globalisation of real estate”. Ireland’s bubble was driven by international credit. Between 1999 and 2007, Irish banks’ net borrowing from abroad went from 10% to 60% of GDP. The lesson from this is that when you plug local real estate into the international circuit board of finance you can get sharp shocks. The amount of credit available can rocket, causing a bubble, but can also disappear just as quickly, causing an economic and social crisis. The solution to that crisis, as argued here, has been to connect the Irish market to a new source of finance — the global funds. In other words, we’ve found a new way to attract global finance into Irish property.
But what if this risks exposing us to sharp fluctuations in available credit? Sadly, our political and economic system’s addiction to the property market means we’re extremely unlikely to see any attempt to consider these risks and implement appropriate regulation, leaving the rest of us to pray that the markets don’t behave according to the destructive, short-term logic with which we are all too familiar.
