Christian Bearman, coo at Valad Europe, answers SCI's questions

Q: How and when did Valad Europe become involved in CMBS workouts?
A: Originally founded in the 1960s, Valad Europe has grown through the acquisition of a number of local businesses in different regions to create one of the largest fully integrated real estate investment management platforms in Europe. In recent years, the company was listed on the Australian Stock Exchange as part of the Sydney-based Valad Property Group, before being taken private last year by management with the financial backing of Blackstone's BREP VI fund. Valad Europe is therefore now completely independent and able to partner with its preferred capital partners on a deal-by-deal basis.

Valad Europe has 60 international institutional investors across 13 different funds and mandates, with over €4bn assets under management. The company employs 220 people in 22 offices in 12 countries across Europe, covering 650 properties and 6,000 tenants accounting for six million square-meters of real estate.

At a high level, our strategy is to match the most appropriate capital partner to the right real estate opportunity according to the risk/reward parameters of the deal in question. These opportunities can be in the form of single mandates, appropriate for large institutional investors or sovereign wealth funds, but also include CMBS/bank work-outs/recapitalisations, portfolio acquisitions and the acquisition of private/public companies, as well as loan books (e.g. NPLs).

Our core competencies are across multi-let light industrial, office and logistic assets, as well as certain retail warehouse properties. We cover Germany, the UK, Nordics, the Netherlands, France and Central and Eastern Europe.

Our capital partners are generally looking for equity, mezzanine and debt investment opportunities, ranging from 10% to 20%-plus IRRs on moderate levels of gearing, on a risk-adjusted basis. Our institutional investors seek a solid, stable yield of circa 8% on a cash-on-cash basis.

A key component of our strategy is to target bank workouts and problem real estate loan books. We aim to provide a one-stop shop, with a holistic approach to asset management and restructuring skills, combined with equity investment, to drive value in the assets and the recovery of debt and equity value for our stakeholder clients. CMBS restructurings are obviously an important - and growing - area within this strategy, with €45bn of CMBS due to mature in Europe over the next two to three years - many of which are stressed from an LTV or ICR perspective, or both.

We have a good track record in terms of CMBS/bank workouts, based on our experience with the Kefren IX (KEOPS) and ECREL mandates, as well as Uni-Invest.

Kefren Properties was a €480m Swedish portfolio of 150 assets, comprising 2,100-plus tenants. We were appointed by both Barclays Capital as the senior lender and the sponsor in July 2010 to manage the assets through an accelerated sell-down and auction process, while enhancing the rental income and capital value. All assets were sold by December 2011 and we achieved full recovery for the senior loan and part of the junior loan in the process.

ECREL is a €250m mixed commercial portfolio of assets spread across the Netherlands, Germany and the Nordics. We were appointed by the investors and senior lender in April 2010 to build sustainable value, before implementing a five-year disposal programme. We were able to negotiate a €200m refinancing package with Lloyds in June 2011, at which point we also acquired a 49% equity interest in ECREL alongside the original investors.

More recently, Valad Europe was selected by Uni-Invest noteholders as their preferred asset manager for the consensual restructuring option of the Opera Finance portfolio of 200 Dutch assets, under a dual-track noteholder selection process. Ultimately, class A noteholders opted for the upfront cash option of the credit bid, which included an immediate cash payment of 40% of the principal - despite the class B, C and D noteholders voting in favour of Valad's proposal.

One core competency of ours that has been reinforced by these bank/CMBS workouts and which is of growing importance in these challenging economic headwinds is the ability to manage complex real estate portfolios with limited cashflow for capital expenditure purposes, ensuring that capex is only invested where it has the largest positive impact on value/sale.

Q: How do you differentiate yourself from your competitors?
A: Valad Europe is unique in a number of ways. Our main differentiator is the scale of our business and the breadth of our platform: we are one of the largest independent real estate investment managers in Europe, which combines a flexible cost of capital with a range of different growth strategies. For example, while there would be plenty of asset/investment managers eyeing a mandate for a £100m UK bank workout, we would be one of only one or two in the running for a €500m European cross-border complex problem loan mandate.

Our network of 22 offices across 12 countries in Europe is vital to our success. Having teams of local people on the ground, who know the local market, speak the local language and build relationships directly with our tenants on a daily basis is invaluable.

Another differentiating factor is alignment of interest between management and our capital partners. As a private company, management is fully aligned to our investors and debt partners and our staff are similarly aligned and incentivised. This means our clients matter to us at all levels of our business.

Q: What are your key areas of focus today?
A: Asset management in work-out situations in the current real estate market demands a different mentality: we are not talking about asset management in the traditional long-term sense, but rather an intensive effort with limited capex resources to drive immediate value in the asset and shape a disposal strategy that allows for debt to be repaid in an accelerated timeframe. The need to trade assets quickly and profitably requires a fundamental change in psychology and approach to the traditional buy-and-hold approach of some firms.

In practical terms, strategic and active asset management in this sense can be achieved by dividing a portfolio up to identify assets to dispose of in the short term that have high vacancies or to invest limited capex in redevelopment potential. The idea is to identify assets with value that can be traded in the short to medium term in order to have a positive impact on debt repayment/recovery. It is a question of making a judgement call in respect of where capex can be best spent to achieve greatest benefit to drive value in the assets or improve cashflow through new lettings.

For example, where vacancies are high, lease re-gears can be implemented to retain existing tenants and new tenants targeted to reduce the void. Repositioning an asset takes longer, but can present meaningful upside and so we may seek to spend capex in these situations.

Finally, assets that are a drag on cash should be sold soonest if not improved. This involves an element of price elasticity and is a function of basic economics, where pricing on a distressed asset must reflect what it will take to sell it. You have to make a call about where to take the short-term pain for long-term gain.

We typically approach asset management by taking a bottom-up view on an asset-by-asset and tenant-by-tenant basis. Together with the amount of capex available, the market the asset is in and the underlying occupational and investment trends are all important considerations.

In an oversupplied office market like the Netherlands, for instance, the emphasis on tenant incentives is greater because - as there is more choice - you are competing on making the asset look good and to offer favourable terms that are attractive to a prospective tenant. Such incentives could involve giving tenants rent-free periods or contributing to a portion of their refurbishment costs. The aim is to maximise income and there are different ways of doing this in terms of lease lengths and rent levels.

At the same time, a buyer for each asset has to be identified. It is not always obvious who that may be, so it is important to understand the local market because it changes from region to region, what sales strategy to develop and how to market each asset best in that local market.

In some places, there may be good areas only 100 yards away from bad areas. Consequently, it is necessary to think creatively about the potential purchaser base, especially if there is a potential change of use with the asset.

Generally, the longer an issue remains unresolved, the greater the potential for asset deterioration and value destruction. If receivers take charge of an asset, for instance, they do not typically have the skill-set to actively asset manage it and - depending on the nature of the distress - it may be better to bring in a specialist asset manager. But even this may not have the necessary impact in the time required, if a more fundamental restructure of the capital structure is required in order to give the best chance of the asset management initiatives having the positive impact intended.

A solution can always be found. Even for a particularly poor asset, a buyer can always demolish the property and benefit from the value of the land, its alternative uses or a new more modern development.

Q: What is your strategy going forward?
A: Around €45bn of European CMBS is due to reach legal final maturity over the next two to three years, but a more proactive and nimble approach to asset management is required to deal with the real estate challenges this will present. We are in a good position to help special servicers, noteholders and banks by providing innovative solutions for their workout needs. Certainly, we have had much positive feedback following the role we played in the Uni-Invest resolution and it is important we build on this momentum.

One clear lesson from the Uni-Invest case is the importance of understanding the nature of capital that is represented by each class of noteholder: they all have different priorities, objectives and pressures. If a noteholder is invested in a number of different tranches in the same distressed deal, for example, they will typically prefer the consensual restructure 'work-out' option that offers greater long-term recovery prospects.

Hedge fund-type noteholders tend to be interested in the short to medium term and in making a trade with a higher upfront cash component in order to convert a bad loan in to a better or 'good' loan. Banks, on the other hand, tend to be capital risk weighting constrained under new regulations and are keen for a cash-based solution that provides liquidity and minimises their risk weighted assets (RWA) capital requirements.

The special servicer for the Uni-Invest loan (Eurohypo) recognised how difficult it was to corral investors with different views, so it appointed an adviser to run the dual-track process and give noteholders a choice of options. Having said that, if there are structural debt issues, it is very rare for a CMBS to hit legal final maturity without these being resolved in advance. I would expect this to happen only in extreme cases in the future, with problematic assets in difficult markets, given the abundance of private equity capital raised to tackle these types of opportunities and the increasingly innovative approaches to providing solutions.

Another lesson from the Uni-Invest case is the attractiveness of noteholder financing to acquirers because it is on more favourable terms than those derived from banks.

Q: What major development do you need/expect from the market in the future?
A: Commercial real estate portfolios of scale are being traded in this market at a 20% to 30% discount to net asset value across Europe. But many banks are yet to start liquidating their distressed assets - Dutch and German banks, in particular, have not taken the full mark-to-market hit on their portfolios - so prices will likely soften further going forward as supply to market grows. The 'bad banks' in Germany, Ireland and Spain are in the early stages of being able to address their portfolio issues, and most banks are disposing of non-core portfolios and refocusing on their core domestic markets.

Pricing is still moving out on some secondary and tertiary UK properties. By comparison, the Czech Republic, Germany, Poland and Sweden remain attractive, with decent liquidity. These regions are exhibiting good underlying economic growth, although it varies according to sector.

CS