US vulture funds focus on French real estate

Copyright: David Lawson 1996

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When American vulture funds move, markets tremble. They are big - very big. Billions of dollars changed hands as the US climbed out of recession and banks sold bad loans. Europe has been waiting for  the same treatment.  But the 'tidal wave' of money forecast by some commentators looms not over the UK, normally the focus  for overseas investors. France is  the focus of attention, with three massive deals worth a total of more than Fr4.8bn (617m pounds) already done and a single loan book three time this size now on the market.

 Even this is just a small taste of what could come. More than Fr100bn (12.8bn pounds) worth of property could change hands in the next few years, says Christopher de Taurines of La Salle, one of North America's largest fund advisers. His firm started the ball rolling late last year, teaming with Lehman Brothers and Cargill Corporations to buy Fr870m worth of loans from Barclays Bank. Goldman Sachs Whitehall Fund has done  two deals since then, taking Fr745m of debt and property from Creditsuez and Fr3.2bn from UAP, the state-controlled insurance fund.

  These figures exaggerate the amount changing hands, as portfolios are being bought at discounts as hefty as 50%. But that is the secret of the emerging market. Most of this property is  considered as rubbish by conventional funds. It is scattered, mainly secondary stuff, in shops, offices and housing away from city centres - a legacy of the boom years, when French banks went even more crazy than the British in backing developers and small investors.

  'That is why you will not see UK and German funds involved,' says de Taurines. But it is meat and drink to vulture funds willing to take high risks for big returns. They demand big discounts to book value and an internal rate of return of more than 20% over three to five years. It is also why they have made no impact on the UK. Banks here took their lumps on bad debts through writedowns. 'The French kept hoping for an upswing which would cover their mistakes,' says Barry Attarzadeh, French specialist for Chesterton. But it did not happen and they are now under huge pressure to sell. 'This is not sudden,' he says. 'Talks have been going on for two years. The US funds  have a lot of money and nowhere to put it, so they are willing to persevere.'

  Cracks in French resistance began to appear when Chirac one the election and started to clean up the economy to meet single currency conditions. De Taurines points out that the government has a huge role in banks and insurance companies, both as owner and regulator, and it is pressing them to sell up so state subsidies can be cut. Annual Government support for the banking sector was estimated to be running at  more than Fr20bn. Credit Lyonnais alone was forced last year into agreeing sales of up to Fr135bn of assets over the next five years to justify a state bailout covering huge losses. It had already hived off Fr42bn of bad loans into a state-underwritten company.

 International liquidity rules have also forced banks to act. Banque Indosuez and Creditsuez had to be recapitalised by the parent group after a Fr7.4bn provision against property losses. Suez group is now understood to be marketing Fr16bn of loans and property from its Banque La Henin subsidiary through Lazard Brothers.  While the Whitehall fund includes investors such as UK veteran Martin Myers, the chief players are from across the Atlantic. They got a taste for  buying loans at big discounts after the US savings and loan industry crash, says de Taurines. Now they are willing to take a punt on doing the same job in France.

 But they are not going in with their eyes closed to how they can get out. There are three possibilities, says de Taurines. The first involves doing a conventional job of tidying up - filling vacancies, redrawing leases, etc - and selling on through the secondary market. That hinges on winning big enough discounts to cover the risk of being stuck with some property. The second would be to reorganise the loans and create a special vehicle which would be sold. The final option is similar, but would involve packaging these into a property company which could be floated. This would overcome the punitive 20% transfer tax.

 It is still too early to forecast which will emerge as favourite among the pioneers, says de Taurines, particularly when more players are expected to emerge. GE Capital and Morgan Stanley have also been sniffing around the market, and big financial groups such as Paribas and BNP have yet to clean up their portfolios.  'The current provisions by banks and state institutions are nowhere near enough,' says Chesterton's Attarzadeh. 'And when property is being offered at less than half replacement cost and conventional finance for development is almost impossible to find, there is bound to be continuing interest'.

  So why are there no other bees around this honeypot? 'It is a complicated market - too complicated for UK investors who have already tended to avoid France because of tax and legal problems, or burned their fingers in Europe,' he says.   De Taurines thinks only ING Barings is a possible punter - but because of its experience in a similar US market. Even the Germans funds, so keen to diversify abroad, are unlikely to be interested, says Harald Blumenauer,[CORRECT] director of the eponymous agency which is one of that country's biggest chains.  'They want safe, stable investments. This is a gamble,' he says. Prime office blocks are their staple diet rather than mortgages on secondary property.

  UK pension funds are also restrained from gambling, while major property companies shy away from the complex task of sifting through hundreds of non-performing loans to find the jewels. There is also a small matter of performance. The French market is still falling: 'It is about three years behind the UK,' says  Attarzadeh. Calculating exactly when prices hit bottom will be crucial for the vultures, otherwise they could end up with their beaks severely out of joint.


Three massive deals have brought French property into world headlines. The trend began when Lehman Brothers, Cargill Financial Services and La Salle Partners clubbed together late last year to buy loans worth Fr870m from Barclays bank. Whitehall Fund, advised by Richard Ellis, then swooped on Fr745m of loans and property offered by Bankers Trust for Group Suez.

Most are non-performing loans made to trading companies during the boom, which accounts for the discount of around 50%. Within weeks, Whitehall won a far bigger prize. it is understood to have paid the state insurance group UAP around Fr1bn for a portfolio with a book value of Fr3.2bn - also dominated by small loans to traders. Whitehall is headed by Goldman Sachs but includes two veteran UK investors. Miles D'Arcy-Irvine's Shaftesbury International will be closely involved in managing the portfolio reorganisation.

Considering the way Barclays began the trend, it is ironic that the partnership also includes Martin Myers, who remained with Imry after Barclays Bank took control. He is involved through his private company, Vines Management. Other trans-Atlantic players still looking for a foothold in France include Morgan Stanley and GE Capital. Both will be interested in what could be an even bigger prize - a portfolio that could be worth up to Fr20bn being marketed by Lazards for Suez Group. Another US giant, Philip Morris, has found a different path for its ambitions, putting up more than Fr3.12bn to fund the biggest French deal of its kind in five years. This involves forward purchase of the 1.3m sq ft (108,000m2) Compagnie General des Eux office development in La Defense, Paris. Chesterton, which introduced the deal, says it equates to the total invested in French offices during the whole of last year. US developer Gerald Hines is also betting on revived interest in France, with plans for a Fr1.8bn office scheme in La Defence.