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Thursday, 15 March 2012

Getting rich with Commercial Real Estate Pt V: Game over?

This is the fifth part in my series on the difficult situation in the  Dutch Commercial Real Estate (CRE) market, of which the last episode has been published a long time ago. Following are the links to the previous articles:

In December, I wrote on the failed auction of a CRE portfolio, owned by the Uni-Invest Group and the serious consequences that this could have for every company that has a large CRE portfolio in The Netherlands. 

This auction failed at the time, due to a total lack of interested buyers, in spite of a 40% discount on the sales prices for this CRE. My conclusion was that the Dutch CRE bubble was about to explode and that this would have grave consequences for the balance sheets of large investors in the CRE industry. Huge write-offs were looming.

However, in those days the ‘CRE bad news debunkers’ at the banks, pension funds, insurance companies and other large CRE investors supplied a ‘good news statement’ to every newspaper and news program that listened to them. 

The statement sounded something like this:

‘Uni-Invest owns real estate of the wrong kinds and vintages in exactly the wrong places. That’s a shame, but never mind! We [all other investment companies – EL] own prime-cut Commercial Real Estate at Triple-AAA locations. Every speculation on write-offs is strongly exaggerated. Trust us, we know we are worth it!’

Yeah, right!

After this, the building and banking industry resumed minding its own business again without having anything solved, until the next series of bad tidings would be on the way.

And last Monday, March 12, it seemed that some bad tidings are present again.The Dutch financial newspaper Het Financieele Dagblad ( wrote a story on a Dutch CRE investment company, called Hanzevast Capital. This company had to deal with very unfavorable valuations of their CRE portfolio at the end of last year. Inquiring minds will find that this story could have strong implications for other investors in Commercial Real Estate. Here is an integral translation of this news story:

The end-of-year valuations of office buildings, that are currently under scrutiny of supervisors, led to turmoil at Hanzevast Capital.

The Hilversum, The Netherlands-based investment company was confronted with a depreciation of 21% on 32 office buildings by CRE-advisor DTZ. Earlier, this Dutch CRE-advisor stated that it reckoned with a depreciation of ‘only‘ 12%.

Hanzevast is currently having an argument with their auditor KPMG on the right valuation for their office buildings. A lot depends on the outcome of this argument. When the auditor uses the latest valuation as the official one, this would lead to negative equity on this portfolio as a consequence of €130 mln in debt.

This is stated by sources that are familiar with the situation. Neither DTZ nor Hanzevast is willing to comment in this situation. The latter sent a letter to 2500 participants in the fund in which this office buildings portfolio is stored. This letter stated that the annual meeting, that was originally planned for Wednesday March 14, is postponed by six weeks as a consequence of ‘delays in the process of annual reporting’.

Pundits in the real estate markets say that CRE appraisers mostly send a concept report after a first analysis. This report is the starting point for some discussions, which often leads to small corrections. ‘However, a correction of this magnitude is unheard of’, according to a large CRE investor.

The official supervisors AFM (Authority Financial Markets) and DNB (Dutch National Bank) warned the real estate industry that both parties would be very critical towards write-offs on CRE portfolios being too low. They warn for a new financial timebomb as a consequence of (structural) vacancy advancing on the CRE market. Appraisers are under heavy pressure to be strict, at a time where transactions are very scarce and thus a price can hardly be set.

The more negative the equity of Hanzevast will be, the bigger the risk becomes that the Deutsche Pfandbriefbank, the German investment bank for real estate, will claim and auction the office buildings. The private investors, that invested €100 mln, will remain empty-handed in this situation.

Last year, these investors voted in favor of a proposal of Hanzevast to store the office buildings, that were spread among various limited partnerships in those days, in one merged fund. This would make the CRE portfolio, that has been dealing with almost 50% vacancy, more crisis-proof. At the time, it was very hard to convince the investors in the stronger funds. A striking detail is that the Deutsche Pfandbriefbank already had the CRE portfolio of Hanzevast valuated in September 2011, by CBRE. This led to a proposal for 21% depreciation to be executed on the portfolio.

All CRE investors will tell you that this is another isolated incident. Don’t believe them, as they are not telling you the truth.

The author of this very interesting article, Mathijs Schiffers, wrote also a column in the FD on the same topic. Here are the pertinent snips of this column.

The  problems with the valuations of the office buildings of Hanzevast Capital show that the Dutch supervisors have all the reasons to be worried on Commercial Real Estate in The Netherlands.

Hanzevast Capital is flabbergasted. 

The investment company lets 32 of its office buildings being valuated by DTZ. It receives a concept-report in which a depreciation of 12% is mentioned. Some discussion follows, which is usual in this kind of situation, and subsequently the depreciation is increased to 21%, which is unheard of. The annual meeting is postponed by six weeks, as the decision must be made, in cooperation with the auditors, which valuation should be put in the official records.

It is unknown whether DTZ became aware of official criticism from the supervisors during the valuation process, concerning the initially ‘mild’ depreciation and decided to revise it. Both parties keep their mouths shut tightly.

That’s a shame. Apart from the question whether the last valuation is the correct one – the colleagues of CBRE already depreciated the same portfolio by 21% - there is a justified concern that valuations are more a question of bargaining than a valid and truthful estimate of fair value. This concern can only be taken away by more openness of the parties involved.
Mathijs Schiffers is absolutely right with his concerns. Although a depreciation of 21% is huge in terms of money and might be enough to bring Hanzevast Capital on the brink of defaulting in this particular situation, one should not forget that this portfolio suffers from a vacancy rate of no less than 50%.

The odds are that this 50% vacancy rate rather increases, than decreases in the coming  difficult years. In spite of the CRE market being on the brink of a total meltdown, many communities and companies stick to their building plans and continue developing new commercial real estate on their dearly paid building ground, only worsening the situation on the CRE market.

I wonder if a 50% depreciation would not be more justified than even this 21% depreciation. However, such a depreciation would certainly be the end of Hanzevast Capital and its investors. And the worst has yet to come…

1 comment:

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