How a Small German Lender Helped Fuel a Giant Property Bubble

(Bloomberg) — Next to Berlin’s airport south of the German capital lies one of the few properties that Cevdet Caner and Guenther Walcher have been fighting to keep after losing much of their real estate empire.

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Known as Project Walter, the development was acquired with financing from Corestate Capital Holding SA, a real estate lender in which Walcher was a top shareholder. Corestate arranged the debt for the purchase, using money from a fund that one of its subsidiaries advised — even though the fund was contending with redemptions.

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Almost three years on, Project Walter lies silent, the future of the hotel and offices that Aggregate Holdings — the investment vehicle of Caner and Walcher — wants to build uncertain after it defaulted on the debt. The fund that helped finance the deal was frozen, leaving investors unable to access their money. Other clients who had separate accounts with Corestate have moved their money to competitors. Creditors have taken control of the firm to try and recoup their money.

With Corestate on the ropes, its role — and that of other private credit firms — at the nexus of a German real estate boom turned bust is becoming clearer. Roiled by the decline of two major real estate empires — Adler Group and Signa Holding — Europe’s largest economy has become an emblem of the excesses fueled by investors drunk on cheap money, and of the hangover they’re now facing as interest rates rise and values tumble.

Corestate financed some of the wilder bets on German property and vividly exemplifies the web of entangled interests that has left the country’s development industry in a particularly sorry state.  Using mountains of cheap money, it helped thinly-capitalized developers build vast real estate empires, benefiting from negative interest rates that sent investors on a desperate search for yield. Often, the developers whose speculative projects it financed were owned in part by Corestate’s largest shareholders, who were betting they could sell the projects for huge prices even before they were completed.The sudden shift in interest rates upended that model, leaving many saddled with projects underwritten on the basis of securing high rents and sales prices that are no longer realistic and with debt loads they can’t afford. Some of those projects, such as Walter, ended up with Aggregate. Many more landed on the books of Adler, the landlord backed by Caner and Walcher. Adler has been fighting for survival since short seller Viceroy Research in October 2021 accused it of fraud and Caner of secretly pulling the strings. Adler and Caner have denied the allegations.

Footing the bill for that borrowing binge are the pension funds, insurers and wealthy clients that Corestate had attracted with its track record  of  double-digit returns. US investment firms such as Pacific Investment Management Co. and Fidelity that bought its bonds are also sitting on steep losses.

“We’re now seeing the consequences of how low rates and easy money made it too easy for buyers to inflate values and create conflicts without investors being aware,” said Nicholas Ryder, a professor in financial crime at Cardiff University’s School of Law and Politics.

This account of Corestate is based on filings and conversations with people familiar with the lender who asked for anonymity discussing non-public information. Caner, Walcher and Aggregate didn’t reply to requests for comment. Adler, which was thrown into fresh turmoil in January when a court ruling threatened to jeopardize its turnaround plan, declined to comment.Project Walter didn’t cause Corestate’s troubles. But it highlights the intricate relationship between the firm, its owners and the real estate projects it financed with money from outside investors. The main fund advised by Corestate at one point had more than a third of its assets in projects that ended up with Aggregate or Adler. Caner was an occasional guest at Corestate’s Frankfurt offices, according to people familiar with the matter who asked for anonymity citing client confidentiality. Walcher even took a large stake.

And like Adler and its backers, Corestate itself relied heavily on debt.

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Founded in 2006, Corestate Capital started out as a small real estate investor focused on Germany. It would buy smaller properties that were below the radar of major private equity firms, package them into funds and then sell them on to investors. That required the company to borrow so it could buy assets before they were sold on. The firm also kept a stake in the funds under a strategy it dubbed “alignment capital.”

To grow, Corestate needed money. By mid-2015, almost a decade after it was founded, the firm still had just around €1.4 billion ($1.5 billion) in assets under management. To help it make “new co-investments with clients” and expand warehousing, it embarked on plans for a capital increase and an initial public offering, succeeding the following year. 

The IPO allowed Corestate to go on a major shopping spree, financed with more capital increases and debt. It took over Hannover Leasing, a provider of alternative investment funds, and Helvetic Financial Services AG, a Swiss company that specialized in arranging mezzanine debt, one of the riskiest segments of the real estate market. Shortly after, Corestate borrowed some €500 million by selling two bonds to help fund future growth — a debt load it eventually was unable to service.

The flurry of acquisitions brought assets under management to more than €20 billion (they eventually reached over €28 billion). HFS became the key profit engine, arranging risky junior debt for developers at high interest rates, using money from funds it advised. Many of the projects HFS financed this way were owned by companies in which HFS’s founder, real estate tycoon Norbert Ketterer, was an investor. Two of those companies later became part of Aggregate’s development unit Consus Real Estate, which was then sold to Adler. Adler has since written down the value of Consus to zero, calling it a “dud.”

“Speculative development is an unequivocally poor capital allocation strategy on a risk-adjusted basis,” said Green Street analyst Peter Papadakos. “Once you overlay the potential for conflicts of interest, then you have a recipe for disaster.”

Ketterer, through a spokesman, said he never had an operational role at Corestate and that money lent to other companies in which he was also an investor carried interest rates that were customary for mezzanine loans. Any such financings were made before these companies became part of Consus and were repaid, he said. 

In cases where funds made “loans to companies in which Norbert Ketterer had an interest, this was publicly known in advance,” the spokesman wrote by email. “Possible conflicts of interest were also disclosed in the prospectus.”

In addition to providing mezzanine financing, Corestate also acquired properties on behalf of clients for whom it ran other investment accounts. In one prominent example, it bought a building in Nuremberg that Gerchgroup was developing — known as the ‘Q’ project — for Bayerische Versorgungskammer, a pension fund which had various portfolios overseen by Corestate.

Ketterer at the time was an investor in Gerchgroup and he was also a major shareholder in Corestate, having sold HFS to the company. The deal for the Q was worth more than €300 million when Corestate announced it in September of 2020. Ketterer exited both Gerchgroup and Corestate by the end of that year. In a subsequent presentation, Corestate said HFS would arrange mezzanine financing for the project as well, in an attempt to highlight how integrated its various units were, though a spokesman said this never actually happened.Three years on, Gerchgroup has filed for insolvency and construction on the Q has stopped.

Many of Corestate’s investors had been lured by its history of double-digit returns, at a time when benchmark interest rates in Europe were negative. For years, the real estate debt business consistently returned between 10% and 13% annually, according to a presentation dated December 2021.

The system worked as long as interest rates were low and valuations went up. But the circular relationships between Corestate’s owners and the projects it helped finance soon triggered the curiosity of short seller Muddy Waters. The firm, known for exposing fraud at Sino-Forest Corp. more than a decade ago, started to bet against Corestate’s stock in October of 2019. It never published its research because German authorities at the time targeted short sellers and journalists who were trying to expose the Wirecard scandal, according to people familiar with the matter.

“Real estate valuations are easily manipulated by asset owners, and Europe is balkanized from an investigatory and enforcement perspective while money moves freely throughout,”  Carson Block, founder and CEO of Muddy Waters, told Bloomberg in February. “When you combine related-party transactions with those factors, seldom is there a good result.”

His bet proved prescient. Corestate’s share price had been on a downward trajectory since reaching a record in 2017, shortly after the IPO. Co-founder Ralph Winter had used the initial rally to reduce his stake. By the end of 2019, he sold the bulk of the remaining shares.

Winter said he never had an operational role at Corestate and that HFS wasn’t integrated into Corestate but run as an independent boutique. He and his family office never had any direct business relationship with Gerchgroup, Consus, Adler Group or their shareholders, he said by email.

Winter’s exit set off a quick succession of new owners, mostly real estate investors taking large stakes only to shed them shortly after. Ketterer and his wife, who had become major shareholders through the HFS deal, exited a year after Winter. Around the same time, investor Natig Ganiyev acquired just under 10%. Soon after, in early 2021, Corestate bought Aggregate Financial Services, a unit of Aggregate Holdings that arranged real estate loans. In the wake of the deal, Walcher gained a stake of around 20% in Corestate. 

His Aggregate Holding had also just become the largest shareholder in Adler Group, having sold Consus as part of the controversial three-way merger that created the landlord. Now Aggregate was trying to secure funding to buy a collection of properties known as the Castle Portfolio. They included two Berlin developments that were set to become a cornerstone of Walcher’s and Caner’s real estate empire — Green Living, a residential development in the south of Berlin, and Project Walter.

To get funding, Aggregate turned to Corestate. But the flagship fund that Corestate’s HFS advised, Stratos II, was facing unusually high redemption requests at the time. Clients had asked to get their money back in late 2020, around the time Ketterer exited as shareholder. Corestate’s HFS didn’t technically run the fund but it sourced the assets and proposed them to the fund’s administrator, a firm called Hansainvest that oversaw it for a small fee. Hansainvest signed off on the funding, allowing Aggregate to buy the Castle Portfolio.

“Prolific related party transactions can rob outsider investors of the potential benefits of independence which may include third-party, unbiased assessment of everything from acquisitions and disposals to valuation of existing assets,” said  Tolu Alamutu, an analyst with Bloomberg Intelligence. “If issuers run into difficulty, extensive involvement of linked persons or entities may add undue complexity to discussions which can be difficult at the best of times.”

Hansainvest had decided in principle to make the investment already at the start of the year, because several existing holdings were expected to mature and generate sufficient liquidity to meet redemption requests that were due by the end of 2021, said Joerg Forthmann, a spokesman for the company. What the fund administrator didn’t anticipate, he said, was a wave of additional redemption requests in the course of the year as the environment for real estate assets worsened.

“The investment was considered to be in line with market conditions,” Forthmann said. “There were no special conditions for the Castle Project,” he said, adding that the debt carried an 18% interest and was secured by about €133 million in assets.

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About a year after extending the loan, the Stratos II fund was frozen. Corestate wrote down the value of its real estate debt business by €392 million, citing the key role the fund had played for HFS and its fee income. HFS eventually lost its mandate advising the fund.

With a major source of income gone, Corestate struggled to pay its debt. The firm is now trying to liquidate assets in an orderly fashion as it mulls a future without the risky financings that got it into trouble, according to a person with knowledge of the plans.

The prospects aren’t much brighter for Corestate’s clients. The debt that the Stratos fund acquired — more than €100 million, according to German daily Handelsblatt — financed the purchase of several developments, with Green Living and Walter the prime pieces. But the properties themselves, many just plots of land that have yet to see construction, were already laden with senior debt, according to a presentation seen by Bloomberg News.

Green Living for instance, a piece of agricultural land dotted with greenhouses, had been pledged as collateral for a €100 million loan from statutory health insurer, even though the property had been acquired for only about €60 million shortly before. The loan was due to be repaid in March last year, but that date has since been pushed back, giving Caner and Walcher more time to shore up their finances. 

Aggregate said in June that it’s in talks with the lenders to the Castle Portfolio about extending their financing. The firm slashed the valuation of Green Living and Walter further, and indicated it may take longer than expected to start construction. 

For the investors in the Stratos II fund, that’s bad news. They agreed to the freeze to allow for an orderly liquidation. But with construction costs rising and property values falling, it’s unclear how much they’ll be able to recover. Assets in the fund had dropped to about €850 million as of March last year, according to Forthmann. That’s down from €1.3 billion in mid-2021, according to HFS’s website.

Other Corestate investors have already exited. Pension fund BVK moved a holding of residential and student housing properties to Aam2core, a firm established by former Corestate employees. Schroders Capital Real Estate took over running a portfolio of retail properties for BVK, which was valued at about €800 million as of 2019, according to a press release at the time. That fund’s value has roughly halved since then, people familiar with the matter said.

–With assistance from Steven Arons, Marion Dakers, Jessica Loudis and James Boxell.

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