Cyprus Mail

Investing in real estate debt

‘Life has a way of testing a person’s will, either by having nothing happen at all or by having everything happen at once’  Paulo Coelho

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 ongoing 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 brought about my taking an active interest in how the collateral or the repossessed loan 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 here is whether Cyprus is ready to move away from the moaning and complaining of populist demagogues, and start searching and demanding for transparency to take over.

And as we all know, in Cyprus only a chat over a skettos coffee can answer that….

Pavlos Loizou, MRICS/VRS

Managing Partner and Real Estate Advisory

Leaf Research (

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