Refinancing Arrives
Elsewhere in the world, re-financing is a common practice in commercial real estate, but in Russia it largely remains an alien phenomenon. While their western colleagues have long learned to take full advantage of this instrument, for Russian developers it is still uncommon. However, with the entry of large Western European banks to the market, and the anticipation of even bigger players’ appearance, re-financing is bound to become an acceptable form of saving significantly on construction loans.
Refinancing refers to the process of raising senior debt intended to replace an existing loan secured by the same assets. The motivation to refinance can include to reduce interest costs (by refinancing at a lower rate), to pay off other debts, to reduce one’s periodic payment obligations (sometimes by taking a longer-term loan), to reduce risk (such as by refinancing from a variable-rate to a fixed-rate loan), and/or to liquidate some or all of the equity that has accumulated in real property during the tenure of ownership or as a result of successful development.
Certain types of loans contain penalty clauses that are triggered by an early payment of the loan, either in its entirety or a specified portion. Also, some refinanced loans, while having lower initial payments, may result in larger total interest costs over the life of the loan, or expose the borrower to greater risks than the existing loan. Calculating the up-front, ongoing, and potentially variable costs and risks of refinancing is an important part of the decision on whether or not to refinance and with which bank. It is advisable that potential borrowers avail of professional advice when seeking to refinance in order to minimize costs and risks. A professional advisor with the relevant experience can manage a competitive tender amongst senior lenders in order to secure the best possible terms for the borrower.
Russia’s commercial real estate market is dominated by local developers, most of which have strong traditional ties with Russian banks that are actively financing construction in all property sectors. Until very recently, western financial institutions had been virtually absent on the market. This allowed Russian banks to dictate lending conditions, which would be considered undesirable by a foreign developer - short-term loans at 10 to 12 percent annual interest rates.
Some of the differences between Western banks and Russian banks active in the commercial real estate market are that Western banks have a lower cost of funds, enabling them to lend more competitively than their Russian counterparts thus creating a market for refinancing. Additionally, Western banks’ overall commercial real estate experience contributes to their ability to underwrite loans more aggressively than Russian banks. This is specifically evident in the longer amortization schedules that Western banks are permitting on Russian loans – 15 – 20 years. However, Western banks are at a disadvantage compared to Russian banks when it comes to specific knowledge of the Russian business environment, the legislation and the ability to be comfortable with construction finance loans meaning that Russian have the advantage when it comes to speed to drawdown.
Last year we witnessed the first examples of large-scale re-financing transactions, involving investment-grade properties. In March 2005, Hypo Real Estate completed its first Russian deal: the refinancing of Gogolevsky 11 Class A office center in central Moscow for Fleming Family & Partners Russian Real Estate. And in December 2005, Eurohypo refinanced Pushkino Logistics Park development, located in the Moscow region, for $130 million, making it the biggest refinancing transaction in Russian commercial real estate’s history.
German and Austrian banks are currently at the forefront of Western banks’ expansion to this country. For them it is a general extension of their operations in Poland, Czech Republic or Hungary, where they have been active since the 1990s. However, Russian market’s growing maturity and immense investment opportunities both in Moscow and in the regions continues to attract international lenders, with bulge bracket investment banking names such as Merrill Lynch and Goldman Sachs likely enter the market in the near future. Investment banks, unlike the German and Austrian mortgage banks, are more likely to sell down the loan to their clients keeping a minimum amount on their own balance sheet. Therefore, the larger the transactions become in Russia, the more interest investment banks will show to the market.