The deals that show you that the property cycle is in full swing

The following blog is from my partner at usfamilyofficerealestate.com.  Akhil Patel from the firm Ascendant Strategy (www.theascendantstrategy.com) explains why the following deals show that the property cycle is in full swing.

In July 2015, German lender, Commerzbank, sold two commercial real estate portfolios for around $2.9 billion.

It’s not a particularly remarkable story but I am bringing it to your attention because it’s an important part of the 18 year cycle, particularly the first half of the cycle – the de-leveraging process.

US funds have been in the vanguard of this process. Having snapped up loan portfolios from US banks in the wake of the 2008/09 financial crisis, they are doing the same in Europe following the Eurozone crisis. The strong dollar gives them additional firepower as well.

Note some of the key facts in the article – all classic elements of the cycle:

•         The bank had to be bailed out by the German government with an $18.2 billion emergency investment at the height of the financial crisis in 2008/09.
•      The bank is selling off part of its commercial real estate loan book, which it describes as “non-core” assets – compared to its “core” ones – which are the loans it supplies to businesses looking to expand, invest, create jobs do all of the things that generate economic growth
•         This will help the Bank meet new banking regulatory requirements (Basel III) under which the Bank needs to hold more capital relative to its assets. It recently raised $1.4 billion by issuing more shares to further meet such requirements.
• ·         Note that the discount (that is the amount by which the sale price is below the outstanding value of the loans) on the portfolios being sold is only 3% – this is significant because this means that the value of the real estate has recovered to levels seen when the loans were made, prior to the financial crisis.

Pay attention to articles like these. You don’t see them every day but this is the property cycle in action.

Banks can only really start to lend to the economy properly once they have got rid of the loans they made in the prior cycle. It takes several years for banks to do this, because they need to see a recovery in the underlying value of the real estate so that they minimize losses and because they have a lot of real estate on their books.

And they have to find buyers – the more the better to generate competition and increase the sale price (which also takes time). Many of these assets are now being snapped up by other banks and institutional investors.

It is only once this unwinding/de-leveraging process has completed that banks can focus on their “core” activities, which is lending to businesses that generate wealth within the economy. The article notes that Commerzbank is a “key lender to the small and midsized companies that make up the backbone of Germany’s economy”. Such companies innovate, create jobs and drive economic growth.

Only when such companies start finding credit easier to obtain does the next cycle gets fully underway.

This means that the “recovery” – in the United States and in Europe - so far has really only got us back to the starting blocks. The race will start now and run into the middle of the next decade.

As an investor you should be identifying those smart deals and going for it.

But you need to do so by understanding how the 18 year real estate cycle works. You can read more about that here.