For Europe’s real estate financing market, 2022 was the most challenging year since the aftermath of the 2007-08 global financial crisis.
However, at the beginning of the year, few would have predicted that would be the case. Lenders had ample opportunities following 2021’s market rebound from the worst of the covid-19 pandemic. Data from consultant CBRE showed a record €359 billion of investment across Europe in 2021. Going into 2022, lenders were ready to capitalise.
That is not to say they were worry-free. Most had expected to see a market correction following a sustained period of high values. An upward creep in inflation in the latter part of 2021 also had some concerned.
But sentiment took an abrupt turn for the worst in February following Russia’s invasion of Ukraine. Beyond the human tragedy, war in Europe meant huge economic upheaval. A spike in energy prices fuelled inflation, prompting central bankers to rapidly tighten monetary policy. After a decade of low-priced debt, rapidly rising rates would spell a new era for markets including real estate.
In March, at the first MIPIM event in Cannes since the onset of the pandemic, Ukraine and inflation were the main talking points. Attendees agreed that property markets had performed strongly in the first quarter, with few seeing a pause in activity at that stage. However, while many said lenders were busy closing deals, some suggested they were more reticent to quote terms on new deals since the invasion began.
By May, it was clear a repricing was underway in debt and equity. Jackie Bowie, head of European real estate at risk management firm Chatham Financial, said at the time: “The short end of the Euribor curve is steep, and the market expects an end to negative rates in the next two months. The substantial increase has taken some borrowers by surprise.”
Lenders were reported to have raised loan margins. Francesca Galante, founding partner at debt adviser First Growth Real Estate & Finance, agreed pricing in January for a loan for a borrower client which closed in mid-May. She noted financing costs – comprising liquidity costs and swap rates – changed significantly during that period.
“The seven-year swap rate moved around 145 basis points. If we had not locked in the liquidity cost, the loan margin for that deal – which is a super-core, 45 percent loan-to-value deal – would have increased by 20-30 percent, with the lenders involved,” she explained.
Data released in October by London’s Bayes Business School showed lenders were active to the end of June. Total UK origination was £23.7 billion (€27.4 billion) – a slight uptick on the £23.3 billion recorded in the same period in 2021.
Nicole Lux, senior research fellow at Bayes Business School, was surprised by the volumes. “I thought the market would have reacted quicker [to inflation and the Ukraine war], but lenders were busy all the way up to July.”
However, by June, at the Real Estate Capital Europe Borrowers and Lenders Forum 2022, panellists were wary. “Certainly, lenders are being a little more cautious,” said Natalie Howard, head of real estate debt at UK manager Schroders, “and the main thing is the concern of the impact the volatility has on values of real estate, and so I think people are pulling back on loan-to-values”.
Howard noted a slowdown in activity as market participants pondered economic conditions ahead of the traditional holiday period across Europe. “I do think there is a little bit of sit-on-hands and wait-and see, certainly in terms of investing in real estate, renewing loans,” she said.
During the summer months, lenders reported fewer transactions to finance. “Some sellers are getting bid 10-15 percent below where they were expecting,” said Michael Shields, EMEA head of real estate debt at Dutch bank ING in August.
“Some buyers accept the discount, and some pull the deal. Most buyers are leveraged, so with debt costs higher, they need the price to come down to hit their returns, and why would they drop their return targets when there is inflation?”
On 23 September, the fledgling – and as it would turn out, short-lived – premiership of then UK prime minister Liz Truss heaped more concern on the industry. Then UK chancellor Kwasi Kwarteng’s tax-cutting ‘mini’ budget sparked a spectacular collapse of the pound, followed by a Bank of England announcement that it would “not hesitate” to raise interest rates by as much as needed to tackle inflation, plus the announcement of a bond-buying programme designed to “restore orderly market conditions”.
“This has caught everyone by surprise,” said Dean Harris, executive managing director, EMEA, at loan servicing firm Trimont Real Estate Advisors shortly after. “Lenders are re-underwriting existing positions, reforecasting their finance costs and stress-testing exit yields across their portfolios. The particular focus will be those loans which are maturing in the next 12-15 months,” he said.
By October, consultancy Oxford Economics warned refinancing shortfalls and declining interest coverage ratios were leading to an “increased risk” of forced sales, with offices and retail at greatest risk.
At the busy EXPO Real conference in Munich that month, debt specialists agreed the fallout from the UK budget was having a destabilising effect across European markets.
At the CREFC Europe Autumn Conference in November, panellists were candid about the situation. “We’ve got interest rate rises that have changed underwriting for new loans and have changed stress tests on existing books. The key driver now is less loan-to-value and more debt service, and therefore we have clearly an almost entire slowdown or pause in new financing,” said Andrew Radkiewicz, global head of private debt strategy and investor solutions at manager PGIM Real Estate, at the event.
Nicola Free, managing director and head of CRE for EMEA at US bank Wells Fargo, said at the event the biggest issue for her as a lender was underwriting against huge volatility.
“You’ve got swings in interest rates, FX rates and cap rates coupled with high inflation and the war in Ukraine, all set against a changing regulatory landscape, occupier demand and ESG requirements – there are so many variables to consider when looking at a deal.”
For some, the market volatility represented an opportunity to provide financing in a disjointed market. In November, US private equity firm KKR spoke to affiliate title PERE about the launch of its real estate credit business in Europe.
“It’s a super-interesting time to be building a real estate credit business,” said Matt Salem, head of real estate credit at the firm. “The world has gotten obviously much more volatile. We’ve seen a lot of repricing on the equity side of the industry, there’s uncertainty around cap rates, there’s uncertainty around valuations. And there’s a strong view that credit and real estate credit as well offers a lot of relative value right now.”
The market mood was poor by the end of the year. In its Q4 sentiment survey of German lenders, Stuttgart-based adviser BF.direkt said sentiment had hit a record low, with respondents saying the rising cost of debt was causing difficulties for lenders and borrowers, with borrowers impacted by negative leverage.
As the year drew to a close, debt market professionals were left pondering big questions – chief among them, how high would interest rates rise, and where would valuations settle? At the end of Q1 2023, as we look back on 2022, those key questions are yet to be fully answered.