ریسک و پاداش قدرت نفوذ در سرمایه گذاری دارایی واقعی در رومانیایی

Emerging markets real estate performance is nowadays heavily affected by lack of investor confidence, risk perceptions, increasing cost of finance and finally market fundamentals. In turn, banks have looked away from real estate as their balance sheets are loaded with non-performing commercial real estate loans. While the blame for debt excesses is being placed on one party (banks) or another (investors) we take an in depth look at a real estate development company active in Romania in order to understand the effects of leverage. We are trying to answer basic questions in real estate investment, in a Romanian context: is there an intrinsic need for debt financing in real estate? What should be considered a sustainable level of debt in an emerging market such as Romania? What are the risks stemming from too much debt and how should they be managed? The conclusions are limited by the focus on a single company but the company is what could be called a representative case for the Romanian investment market.

The last real estate driven financial crisis has been thoroughly investigated and conclusions were drawn about behavioral economics, interest rates, risk management and many other interesting subjects. Romanian real estate, as a phenomenon at the frontier of the Western born real estate boom, was however rarely considered for research bar for the international consultancies assisting investors in the region. Distant as it is from the center, the real estate development and investment spree worked however in much the same manner as in more mature economies, fueled by bank lending and strong demand, only that everything happened on a fast track forward during the course of, say, 4-5 years. We are trying to shed light into the rationality that led to such a fast expansion and contraction of a market that was simply non-existent at the end of the 90s by investigating the characteristics of decision making related to the projects developed by the local subsidiary of a European developer. In doing so we are trying to understand the decision making rationality at work when significant levels of debt are accessed, risks are overlooked and rewards are overestimated. Regarding the methodology, we start by taking a look at the Romanian real estate financing market as the root of the property investment meta-narrative and move to the concrete company level approach in trying to understand the risk/reward trade-off and the consequences for the company. At company level we have conducted a series of non-structured interviews with management and operational staff in the local subsidiary and we also had several meetings with the general management of the group. We have gathered data about the projects and we had access to project calculation sheets, financing contracts, cost variance reports. We interpreted the data in relation to the wider market context.

Over time few issues have been as thoroughly researched as the reasons for which companies adopt acertain capital structures or another Gau and Wang, 1990. Recent studies of developed real estate financing markets document that real estate companies tend to use favorable conditions on the financing and capital markets to their full extent. Ooi, Ong and Li 2010 demonstrate that US REITs time their capital structure decisions in an opportunistic manner in order to take advantage of opportunities on the financing markets. However the conclusion that seems to arise from examination of the real estate development companies active on the Romanian market is that the extent to which debt was used is clearly connected to the mythology of continuous growth, widely spread at the time In a very simplistic textbook approach, when considering capital structure risk/reward trade-offs decision making should concentrate on the analysis of the tax shield effect of using debt, the bankruptcy risks in case of overleverage, the benefits from greater diversification brought by debt usage and, of course, the greater return on equity. In the case of real estate development companies active on the Romanian market we would argue that the debate that would put on one side the proponents of thrift and care in using debt and on the other side the investors that are betting their money on the leverage effect never took place. As the interviews with the managers of the company in question showed, the debt service coverage requirements were met by assuming very low level of voids (maximum of 7%), with no leakages (triple net rents) and the exit values were determined betting on the convergence theory and the squeeze of the yield spread between core markets and the periphery. In the project pro-forma the assumption for the sale price of project C had an exit yield of 6.2 % and for the exit price of project D an estimation of 7.3%. The rental levels were considered stable and safe long term, with maybe a slight (3-4%) decrease over 5-6 years due to more developments being delivered to themarket. Regarding assumptions for the variations of interest rates, interviews showed that managers were considering the low cost of funds to be maintained long term, and were expecting more competition between lenders (with more foreign banks willing to enter the market). This factor would have triggered even better financing terms, on a par with the financing products available in core markets in Europe. In such circumstances the managers responsible for financing decisions at the time were trying to ensure a less costlyway out from current lending contracts in order to be able to take advantage of future improved financing terms by refinancing with other lenders about to enter the market. In some cases (for the project C) the managers agreed to take on additional cross-collateral obligations, considering that better terms would be obtained through refinancing, as there was no shortage of lenders. In fact, the very fact that the banks started in late 2008 to ask for supplementary guarantees (unusual at the time) should have ringed an alarm bell, but this did not happen. In the aftermath of Lehman Brother collapse, there was still optimism about the future of real estate. The effect of this epidemic of optimism was that companies used debt not based on calculating the tax shield effect, or various costs of debt, but they used debt simply as much as they could. The usual caveats that are designed to protect cash flow in unfavorable scenarios were set aside by using assumptions about the future. Most of the companies are using the scenario analysis tools with three usual types of assumptions: optimistic, realistic and pessimistic. In the case of Romanian real estate in particular, due to the mythology of continuous growth, banks and investors alike had pessimistic scenarios that now look completely unrealistic. The expectations of foreign capital upon entering frontier markets like Romania are that the risks embedded in a young economy will be covered by the growth prospects. In numbers this meant high IRRs. The high performance expectation was not covered by serious risk analysis because the pessimistic scenarios were in any case very optimistic about the future. This meant in fact that companies took on too much debt for the developed projects because they could do it and because their risk analysis did not take into account all the black swans that could show up. In the aftermath of project A, the decision makers in the analyzed company allocated to Romania a much bigger chunk of capital, due to their perception of the relationship between risks and rewards. This also encouraged them to move to project B in a courageous location outside of the capital and to take on debt on amuch larger and riskier scale for Project D- including a very expensive subordinated loan. such markets and to their perceptions of possible risks. If the meta-narrative of continuous growth is in place,the risks are almost non-existent and the logical conclusion is to take as much debt as possible in order to Regarding the sustainable level of debt, the analysis of the development projects shows that project A was sustainable because of the favourable investment market. The predictions about the future from the developer, the financing bank and the subsequent long term buyer were all positive and the 75% LTC looked even a bit conservative. For the developer the assumption was also sustainable because he could sell the building quickly. For the long term holder, variations in rents and voids might have created a situation where the loan covenants were breached and a solution had to be worked out with the bank. To see the limits of leveraging we can take a look at project D. The high leverage did not help the project as many other assumptions were not accurate. In effect, the high leverage was not the problem of project D, but the entire strategy. Working out a solution with the bank for this development will require a lot of effort. Regarding risk management technics that would have worked, after a serious look at the properties in question and at the decision making process in the analysed company, it can be said that in fact there are no easily available risk management technics that would have prevented overleveraging in project D. The previous successes (project A and B) compelled the company to move quickly (and in the same time) to projects C and D. We can argue in retrospective that there were no methods or metrics to be calculated that could affect appreciation. The simplest tool of risk management, the cash flow simulation, should probably have taken into account vacancy levels of 25 % and rent decreases of 20%. But such proposition at the time would have not been taken into account. We can say in the end that the avoidance of risk would have come together with avoidance of opportunities, and this would have been very hard for managers to achieve.