Will vendor finance get pension funds investing in the Irish property market? Shayla Walmsley reports
When Ireland's finance ministry set up the National Asset Management Agency (NAMA) in 2009, its mandate was to generate the highest possible return from the disposal of property assets linked to €74.2bn in non-performing loans from five Irish banks. Since then, it seems the market has done everything to thwart it. Towards the end of 2009, the only transaction registered by IPD had taken place in the first quarter and overall market activity, excepting a single acquisition by Google, totalled a meagre €60m.
Even with recent sector-specific government measures to end uncertainty, Alan McQuaid, chief economist at Bloxham, believes the primary obstacle is macro uncertainty - and that it will be a few years before it improves. "Commercial property might pick up slightly but there will be no residential pickup," he says. An otherwise positive European Commission report published in December pointed to the weakening economic effects of higher-than-anticipated unemployment, fragile market sentiment and the continuing euro-zone crisis.
In a struggling real estate market, the government has addressed obstacles to activity, ending uncertainty over upward-only rent reviews and reducing stamp duty. For its part, NAMA is offering potential buyers 70% financing to take Irish assets off its hands on condition they come up with the other 30% upfront. Spokesman David Clerkin says it will provide finance "in certain circumstances, on a highly selective, targeted basis" and "only if it offers a more attractive proposition than other disposal mechanisms".
The offer applies only to domestic assets that make up €18bn of its exposure, compared with €1.3bn in Northern Ireland, €6bn in London and €4.7bn in the UK. NAMA also has €1.5bn in mainland European exposure. While it approved asset sales totalling €6.2bn in 2011, 80% of the approved sales of assets were located outside Ireland.
While insurer Prudential has reportedly accepted vendor finance to acquire One Warrington Place, a prime Dublin office block, pension fund interest in NAMA's Irish assets has come from outside Europe. A source close to the bidding says one of the 30 initial bidders was a Canadian pension fund with no intention of availing itself of the vendor finance offer.
While making more finance available widens the pool of potential acquirers beyond equity investors and those with existing debt relationships, liquidity isn't necessarily an issue for pension funds or, for that matter, the private equity companies that are understood to be the primary investor group circling Irish assets.
"NAMA's staple financing will probably assist, but overseas investors who are showing the strongest interest in Irish assets, tend to have their own sources of finance," says Andrew Muckian, head of the commercial property department at corporate law firm William Fry.
Domestic pension funds face additional constraints. "I don't think vendor finance is an issue for pension funds for a couple of reasons," says Jerry Moriarty, policy director at the Irish Association of Pension Funds. "Firstly, they are probably still reluctant to invest in Ireland because of the recent experience [the fall in property values] here. Secondly, credit isn't an issue for them - and in any case pension funds are prohibited from borrowing."
Former Willis consulting actuary Joe Byrne points out that, traditionally, Irish pension funds would have held 8-9% of their portfolios in property. Now the figure is 4-5%, primarily invested in the domestic market. "Many would like to diversify into overseas property but they can't get rid of the exposure they've already got," he says.
Infrastructure is a different case. The €5bn Irish National Pensions Reserve Fund (NPRF) in November said it would invest €250m in domestic infrastructure after mulling an allocation since 2008. It will make the investment via a target €1bn fund set up by AMP Capital to acquire privatised infrastructure assets, potentially including development projects. AMP Capital aims to bring other pension schemes into the fund.
Even if 70% finance were to tempt potential investors in the real estate market, Colliers International director, Declan Stone believes there is still a mismatch between sellers' and buyers' expectations. "The major private equity players won't buy something for €50m. They'll want to go north of €200m and they'll probably be looking for a €1bn-plus portfolio," he says. Hence NAMA is currently looking at repackaging some assets into more attractive portfolios.
"We've seen private equity firms looking around the market for IRRs in the mid-to-high teens," adds Stone. "From the seller's perspective, things are bad but they're not that bad. Our experience has been that they just won't sell at those prices."
As Douglas Crawshaw, senior investment consultant at Towers Watson, points out: "Anything that gets the market moving in a positive way without flooding it is clearly a good thing. The question, as always, is the price."
But Crawshaw sees two potential drawbacks to vendor finance. The first has to do with the absence of competition for debt. "If you can't pitch one bank against another, as an investor you risk not getting the best deal because NAMA or any other seller could offer less than the best price," he says. "If there's no competition, there's no need to be competitive."
The second is the risk that pricing will not be adequately tested "because you have the lever of coming to a vendor with a bag of cash", he says.
Vendor finance is not a new idea - even for pension funds. Crawshaw points to one mooted UK deal involving a non-pension fund seller where an unnamed pension scheme was meant to come up with the vendor finance. In that case, the deal never came off. But given the current appetite for property debt funds he sees no obvious reason why another one might not. "If a pension fund had €500m in buildings it wanted to sell, it could offer debt to the purchaser through the fixed-income allocation. It depends how desperate the pension fund is and why it wanted to sell such a large portfolio," he says.