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Investing in real estate debt

Investment in private real estate debt is the acquisition of performing or non-performing real estate loans from private lending institutions or from government sponsored ‘bad banks’.

Investment in Cypriot real estateLIFE has a way of testing a person’s will; either by having nothing happen at all or by having everything happen at once.

Since the ‘bail-in’ for Bank of Cyprus’ deposit holders was agreed at 47.5%, the new ‘hot topic’ for discussion is real estate debt. Mortgage backed residential loans, commercial loans, non-performing loans, etc. are all expected to be up for grabs as investors begin to circle local financial institutions.

Investment in private real estate debt is the acquisition of performing or non-performing real estate loans from private lending institutions or from government sponsored ‘bad banks’. The investor acquires the rights to receive repayments of loans secured against real estate assets.

There are two main categories of loans; performing and non-performing.  Loans may be performing in that interest is being paid and the borrower is not in breach of minimum Loan-To-Value (LTV) ratios (i.e. the outstanding loan balance is below a certain ratio to the value of the property) or interest coverage covenants (i.e. the interest expense is below a certain ratio to the income produced by the property). The investor is typically buying the right to receive future interest payments and principal repayments. Loans may be non-performing in that the borrower is in breach of minimum LTV ratios or interest coverage covenants, although the borrower may still be paying some interest on the loan.

In the case of non-performing loans, the investor’s cash flow is more directly related to the profile of the asset. The income from the loan is essentially a function of the real estate asset’s rental income; whilst the repayment of the principal is essentially a function of the capital value of the real estate asset at the end of the loan. There are two main options open to the buyer of a non-performing loan:

The lender can exercise their rights to repossess the asset. If the asset is not sold immediately, this requires on-going management of the asset. This raises the issue of what obligations the lender has to the borrower once they have seized control of the asset.

The lender can co-operate with the borrower to ‘work out’ the loan in an orderly manner. In a portfolio context, this may involve disposal and active management of assets or development or re-commencing development of development assets.

For the lending institution the range of choices may make things slightly more complicated. The first part of the exercise is to identify and divide assets into core and non-core, and into performing and non-performing. The second step is to establish a restructuring unit, which will attempt to carry out a rundown of non-core portfolios without imposing excessive strain on capital. The third step is to decide on the general and on the specific strategy for each asset; to hold the loan to maturity, to make it available for sale, to carry out some form of yield optimisation exercise, or to ‘work out’ the loan as described above. For each of these steps the main decision is whether the institution wants (and is capable) to have an active or a passive portfolio management strategy.

To a considerable extent the range of options available to the lender will be determined by the profile of the loan and of the asset. Are the assets standing investments or development opportunities? Do the assets require specialist management? How is the borrower behaving? What is the institution’s time horizon and/or objectives?

Two examples highlight the value of taking an active interest in how the collateral or the repossessed loans are managed. The first is the strategy followed by the FDIC (Federal Deposit Insurance Corporation) in the USA, where in order to avoid ‘fire sales’ the real estate advisor is encouraged to source investors who will take an equity position in the asset, i.e. the FDIC acting on behalf of the lender becomes a JV partner in the development/investment of the asset capitalising on the investor’s expertise and lowering their entrance costs. Similarly, NAMA (the ‘bad bank’ set up in Ireland) has recently announced that it will jointly develop a residential tower in Dublin’s docklands and, separately, that it is providing the financing for some half-finished projects to be completed. In both cases the institutions have realised that by investing they are also creating assets ripe for disposal in the years to come.

The question is whether Cyprus is ready to move away from moaning about destitute, populist demagogues and preaching about the need for transparency, to taking active control of the situation. And as we all know, in Cyprus only a chat over a coffee can answer that….

Pavlos Loizou
Managing Partner | Real Estate Advisory
Leaf Research
[email protected]

Readers' comments

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  • Sarah Kaufman says:

    Whether you have lots of money and great credit starting out, or no money and lousy credit starting out, either way, if you truly want to make a serious bid at building a property empire then you cannot discount the importance of learning how to find investor partners and equally how to find private lenders to help fund your real estate investing.

  • Denton Mackrell says:

    @Nigel and AndyP. Agreed. I assume that Lane Homes is the same company as that involved as the defendant in the 2009 civil action by a British couple who alleged that their developer had engaged in double selling. At some stage, the plaintiffs’ original lawyers ended up also acting for the defendants. Having switched lawyers to Yiannos Georgiades of Nicosia, the plaintiffs were fortunate to stop in the nick of time the Land Registry removing their sales contract and replacing it with the second buyer’s. Without their prompt legal action, they would have lost their actual property and their entire investment of CyP 377,000 after an earlier court had failed to order the return of their money.

    Details of this case were reported in Cyprus Mail in 2009 and as case 11.6 in the chapter on immovable property fraud in Alan Waring’s recent book Corporate Risk and Governance (Gower ISBN 9781409448365)

  • andyp says:

    Denton.

    I have read the thread and this news must be very worrying for the party involved and indeed everyone else with no title deed and a developer’s mortgage on their property.

    Makes my original question even more relevant but unlikely to be answered.

    I assume the banks will be going after the victims rather than the perpetrators as they assume easier prey for their own negligence.

    Pavlos publishes some interesting and informative articles and if you read them there is generally a nod and a wink to a problem. He and more like him are however needed to shout rather than whisper and help those who in reality will be the ultimate victims of these new investors in Cyprus real estate debt. The victims.

  • @Denton Mackrell – I’ve just posted some information about the company that’s gone into liquidation (Lane Homes Limited) on the Eastern Forum.

    The company is still active in the UK and I have posted their details + names and addresses of their directors.

    I don’t know why the BoC isn’t pursuing them in the UK? Too much trouble for them perhaps?

  • Denton Mackrell says:

    Adding to the previous two posters’ comments, I’ve just seen on Cyprus Eastern Forum a post from a lady who got home (in Paralimni) to find a notice pinned to her front door (and similarly to neighbours) from ‘Receivers’ to the effect that an application had been received to repossess her property. Apparently, she has already paid in full so I assume the debt default is on the developer’s mortgage.

    Alpha Bank has already tried this trick of unilaterally transferring a developer’s debts to his hapless buyers (see e.g. Liasides bankruptcy; and current class action in the UK against Alpha Bank). None of this debt transfer dodge is doing Cyprus one iota of good for its reputation internationally and the diminishing likelihood of new buyers of property coming from abroad any time soon.

  • Martyn says:

    Pavlos sets out the opportunities and threats as determined by what we might call ‘The New Banking Practices Manual’ (2008 Credit Crunch Edition, Revised 2009 (Ireland), 2010 (Greece), 2011 (Portugal), 2012, (Spain), 2013 (Cyprus).

    In the case of Cyprus, the Vultures will have been circling since March 15, the hungrier ones well before that even, and the brighter, more sharp-eyed ones will already have sensed that amongst some potentially ‘rich pickings’ there will be a considerably higher proportion of diseased or afflicted prey.

    These varieties of Red (‘real estate debt) Perils will not be for faint-hearted investors, nor, I suggest for innocent lottery winners, inheritors of family fortunes or those who have just collected their hard-earned Tax Free Pension pension sum!

    In Cyprus many, maybe most, of the apparent ‘opportunities’ will be tainted by tangled webs of various and often over-lapping systemic defects in building/construction, land development, legal, planning, banking and taxation practices, many of them unique, it seems to this ‘Sunshine Island’.

    Thus, I reckon the very final Paragraph of Pavlos’ piece ought to have been in Capital Letters – together with reminder that Cyprus coffee can be very, very bitter!

  • andyp says:

    Fair enough Pavlos but what about the elephant in the room, the developer mortgages secured on sold properties where buyers were misled and unaware of their existence?

    Will these be packaged and sold as an investment opportunity?

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