Mezzanine finance transactions have grown increasingly popular in Germany, driven largely due to high residential construction volume and tightening of lending policies by German banks.
Although mezzanine finance is a common term, there is no universal definition of it, primarily because it could be structured in a multitude of forms. The most common mezzanine finance deal is a two to five years financing transaction where an investor receives from a real estate developer a combination of some form of subordinated debt and a share of the project’s earnings or profits.
In the United States, mezzanine finance funds are also in the spotlight. Blackstone Group’s Real Estate Debt Strategies IV fund, which closed in 2020, had raised a total of $8 billion by September of that year, well ahead of its $3 billion initial target. By the end of 2020, about $2 billion of the fund’s capital had been called. In total, 2020 mezzanine funds witnessed an increase of 200% in aggregate capital to $26 billion of commitments, according to Ernst & Young.
However, mezzanine funding is largely a matter of preference for U.S. developers (unlike for developers in Germany, where mezzanine financing is more of a necessity. U.S. developers often plan to finance around 10% of total project capital requirement with mezzanine funds to be able to decrease their equity investment share from ~30% to ~20% of total project capital requirement. In Germany, real estate projects were typically financed with a 30%/70% equity/senior debt combination. Only recently, when German banks started to use lower LTV ratios for new real estate projects, did local developers start to consider mezzanine funding for their financing needs.
On June 25, 2021 Flatow Advisory Partners Invest announced that it raised a €200 million mezzanine debt fund. The German office of Florida-based law firm Greenberg Traurig advised Flatow Advisory Partners Invest on structuring and raising of this fund. This German lender planned to hold the fund’s final close at the end of December 2021 at its target size of €250 million. On December 9, 2021 Bain Capital Credit announced that it agreed to a funding line of up to €183 million to another German private debt platform, Linus Digital Finance AG. The terms of their loans are usually between six and 48 months.
In the last decade, German real estate developers have been quite active. The amount of issued building permits in Germany has risen consistently since 2010, with the exception of the COVID-19 2020-2021 period.
The amount of construction activity in Germany has likewise been growing during the same period, reflecting optimism not only in residential development, but in real assets investment in general.
However, the German banks have recently become cautious regarding future growth in real estate, especially the residential sector. In March of 2021, Deutsche Bank published a report in which it warned that the residential house price cycle in Germany could end in 2024. Ms Claudia Buch, vice president at Bundesbank, speaking to CNBC reporter Karen Tso on November 25, 2021, said that the German banks were vulnerable to a housing bubble and that they needed to be forced to hold more capital in preparation for a turnaround of the housing market.
Bundesbank’s Bank Lending Survey conducted in October 2021 confirmed that the German banks took this potential scenario in practical consideration and were in the process of tightening their lending requirements for residential real estate construction projects. Net percentage of banks that tightened their standards was +3% for loans to enterprises (compared with -3% in the previous quarter) and +4% for housing loans (compared with -7% in the previous quarter).
Tightening lending policies created opportunities for mezzanine finance in the German real estate market. CBRE estimated that around €85 billion was invested in German commercial and residential real estate in 2019, with a slight drop in 2020 to €80 billion.10 For a market of this size, even a single digit percent reduction in available traditional senior loan funding in 2021 created a multi-billion euro market for providers of mezzanine finance for real estate projects in Germany. Bain Capital Credit was the first of major U.S. fund managers to offer mezzanine funding to German real estate developers. Whether other U.S. real estate funds decide to participate in this opportunity remains to be seen.
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