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Romanian Opportunity
ECT seeks to capitalize value by providing solutions for the above-mentioned issues:
- To gain exposure to residential real estate market profit potential, institutional investors need vehicles through which to deploy their funds. As of now, the only way to do it is through buying stocks or bonds issued by the few real estate developers listed. We intend to provide to institutional investors an alternative solution for investing in a carefully vetted diversified portfolio of residential projects.
- If an investor wants to diversify its capital allocation geographically countrywide, again it has a very limited choice of options.
By investing in projects countrywide, we will provide our shareholders with a geographically diversified portfolio to take advantage of the difference in growth rates of major cities in Romania.
- By providing capital next to or instead of bank financing, we provide to residential developers also an accompanying business-oriented mindset plus a flexible set of conditions that can speed up the project execution and capital turnover.
- For the individual investors, we want to facilitate access to the residential real estate market by lowering the entry barrier of capital and eliminating the post-investment hassle.
Investment Objectives & Policies
ECT’s objective is to provide its shareholders access to real estate investment opportunities that are expected to achieve above-average returns on short, medium & long-term capital appreciation.
The Investment Objective is to achieve nominal returns above 15% p.a.
ECT intends to take advantage of any investment opportunities and therefore has no predetermined views on the characteristics of future investments and is not subject to any restrictions. However, the Investment Policies involve 6 pillars based on which ECT seeks to create value for its shareholders.
1. Early-stage developments acquisitions
Most commercial banks are requesting a specific threshold of presales, such as 20-30% of a development’s total number of units, as a precondition for financing the construction.
As a consequence, most developers are offering attractive discounts for these first sales, to meet the financing banks’ request. ECT will seek to capture the price differential between early-stage price and market price upon completion. The price discount offered by developers will vary depending on the project stage, duration, size of the transaction and the advance to be paid. The tenor for this kind of transaction will be ~12-18 months.
There are two major risks to this approach: price risk and counterparty risk. A slowdown in demand, wages growth, a contraction in the economy, rising unemployment may put pressure on real estate prices and cause a market downturn. The price discount at which ECT pre-contracts should provide a sufficient cushion for an exit before the downturn accelerates. The counterparty risk refers to the inability of the developer to finalize & deliver the units to the market.
We believe this risk, and partial price risk too, to be mitigated by extensive due diligence and risk rating of the developer and the project, before the transaction, factoring in the track record of previous projects, reputation, unencumbered property title over the land (if available), valid building permit, bank financing terms & conditions, location, targeted clients, etc.
Early-stage pre-contracting is one of the best opportunities the current market has to offer and will be the main focus and allocation of our investment strategy in the first two years.
2. Mezzanine investment
The capital structure of a project starts with the equity of the shareholders (developer) - which undertakes the highest degree of risk against the expectation of the highest return, and continues with several layers of capital, like senior debt, junior debt, and mezzanine investment. Wherever the equity of the shareholders is not sufficient (again, as a precondition for bank financing) or when the additional need for capital arises during the execution of a project, ECT will seek to provide the necessary capital to the developer under the form of an unsecured investment, subordinated to the bank loan.
While mezzanine investments are typically unsecured and subordinated, there are other elements of comfort that could be explored as weak collateral, like the holding on the SPV’s shares or getting a personal guarantee from the main shareholders. The source of the investment reimbursement will be the sales of the completed units, under a pro-rata agreement with the bank.
Mezzanine investments are inherently riskier than secured loans and close to the equity partnerships level of risk.
However, the risk is a function of the developer’s trustworthiness, the stage of the project (it should have an unencumbered property title over the land, a valid building permit issued and bank lending secured), the location of the project, and the size of the capital allocation.
Mezzanine financing in real estate is a niche with great potential, with little institutional presence, mostly dominated by individual investors within the close circle of friends & family of the developer’s shareholders.
Mezzanine investment should provide returns well above regular bank lending rates and become a significant source of income, another main focus, and allocation of ECT’s Investment Objectives & Policy.
3. Equity partnerships
Equity partnerships usually, but not necessarily, are needed in the early stage of development, like in land acquisition or permitting process. ECT will own shares in the developer company, contributing to the profit/loss of the project in the same proportion as its participation in the equity. ECT will be involved in the management of the project, strategic decisions, selling prices, etc.
This is the riskiest of the 6 Investment Policies. ECT will take advantage of the experience brought in by the ECM in the selection process of these equity deals.
ECT will contribute to the profit/loss of the project in the same proportion as its participation in the equity. The allocation of capital towards Equity partnerships will be maintained conservative.
4. Distressed assets acquisitions
ECT will acquire assets selling at discounted prices versus its market value. This may include assets sold by banks/other creditors in enforcement procedures, insolvency, bankruptcy procedures, or other illiquid circumstances. ECT will ECTher continue with the development of these distressed assets or sell them outright for immediate return.
Distressed assets bear mostly legal risks, but also development risks related to permitting, design & construction.
This Investment Policy has a rather cyclical nature and is most likely to produce the best results when transactions are made in a recovery phase of the real estate market, after a severe and/or prolonged downturn. By its nature, the allocation to this business line will be maintained conservative.
5. Acquisition of income-producing assets
In a strong growing market, the asymmetric information competitive advantage will tend to get competed away, therefore the long-term investment strategy of ECT will be to put together income-producing portfolios of residential, commercial, and/or retail assets, with attractive yields for large institutional investors.
Over the long term, the market cyclicality will incur significant volatility in the Net Asset Value, large drawdowns, and a lengthy recovery. When building the income-producing portfolio, the focus of ECT will be to invest in the locations and at the acquisition prices that are more likely to conserve and grow the value of shareholders’ equity.
Income-producing assets portfolio is a target for large institutional investors like pension funds and also provides a steady source of cash flow to be reinvested. Besides the yield income, the profit profile can be enhanced by improving the effectiveness of asset management (tenants quality, lease terms, etc.) and by compressing the yield between acquisition and market value.
Furthermore, the income-producing assets will smooth out income volatility in case of market downturns. This business line will be another focus to capital allocation.
6. Opportunistic Investments in Old Inventory
Residential units built before 2000 may present attractive returns for short-term transactions when units are sold with discounts of at least ~10% below market prices.
Given the nature of the transaction and the short period, we see only a marginal price risk that should be covered by the ~10% discount cushion of the acquisition prices.
We will target mainly mid-priced opportunities (~60,000 euro/unit), with good marketability and we expect to roll over this capital allocation 2-3 times/year. This business line will provide a highly liquid and fast capital turnover.
7. Land development/zoning
Newly added to our investment policies, land development transactions can provide significant profit potential under the current market circumstances:
- High-interest rates environment imply lower valuations over medium to long-term investment periods.
- The permitting situation in Bucharest is putting pressure on available-for-development land prices.
- New areas are opening for development across market segments: logistics (adhering to Schengen induced), residential - in Bucharest adjacent zoning and leisure (PNRR funding).
The main risks here come from the permitting process, which has been complicated in nature and time-consuming.
With the proper organization our structure can provide, we believe we can capture a significant profit margin over 12-18 months tenors, even more important, as it crosses over to our other business lines.
