This is the second of two parts of our overview of real estate debt specialists’ 2021 predictions. To read the first part, click here.
The influence of non-bank lenders in Europe’s real estate debt market has been growing steadily since the aftermath of the 2007-2008 financial crisis. However, many in the industry expect an acceleration of their growth during 2021, due to the market dislocation caused by the covid-19 pandemic.
Real Estate Capital spoke to property debt experts to gather their views on what will be this year’s key trends. Here is the second part of our findings.
Alternative lenders will capitalise on bank caution:
Many banks will continue to limit their client and sector exposure in 2021, according to sources. “Last year, the UK banks were providing liquidity, but largely reserving it for their existing clients,” said one debt advisor, speaking anonymously. “This was partly because the revolving credit facilities they had arranged pre-pandemic were drawn down far more than they had expected they would be in 2020. Therefore, we see a pullback from the banks on lending to new clients.”
The advisor believes private debt fund managers have assumed the role of the sector’s leading development lenders and will consolidate that position in 2021. “The funds that do development finance are being shown a lot more opportunities, and they are able to charge more than pre-covid. So, they can cherry-pick projects and build their books, while offering lower advance rates than pre-covid, but at higher pricing. A lot of them have deployed their funds and so are raising again for 2021.”
Dan Smith, chief executive of Fortwell Capital, a London-based alternative lender, believes the real estate expertise within the non-bank lending industry will support such organisations’ ability to provide finance despite the ongoing uncertain circumstances. “For alternative lenders like us, who have experienced property people in them, we can take an objective view on what the true underlying value of the property is. I think, in 2021, we will see more alternative lenders active than in the previous two years because the mainstream lenders will be less active.”
Borrowers will aim to diversify their sources of funding:
With less senior finance available from banks, borrowers will be encouraged to diversify their sources of debt capital, the anonymous debt advisor argued.
“The UK clearers are beginning to question whether £100 million (€112 million) revolving credit facilities generate enough profit for them, so they are likely to reduce the size of such facilities,” he said. “It is also likely the increase in loan pricing we have seen since the start of the pandemic will continue, even if it falls back from its peak.
“So, borrowers, such as the REITs, will need to diversify their sources of finance as clearing banks reduce their hold levels. They will look to alternative debt products such as bonds and private placements. Borrowers will also be focused on having a mix of maturities. That means the key objectives for borrowers in 2021 will be ensuring the right level of diversity in lenders, debt products, and maturities.”
He expects to see more listed real estate companies move towards an unsecured financing model. “In 2013, we saw several REITs go unsecured, with another wave in 2017, as they sought more operational and flexible financing. I expect another wave of REITs, that may have so far done asset-level financing, go unsecured as they reach the scale where that makes sense.”
Lenders will continue to diversify their offer:
Debt providers will also focus on broadening their debt product offering, to take advantage of a greater range of opportunities in 2021, sources said. Michael Kavanau, head of debt and structured finance for Europe at consultancy JLL, points to lenders including private equity firm Apollo Global Management, which has diversified to provide loans on behalf of group insurance companies Athora and Athene, as well as investor Kennedy Wilson, which has partnered with financial services group Fairfax.
“We have seen many lenders move out of traditional silos and create a continuum of products. They are all playing in different parts of the capital stack, ranging from general accounts at 150 basis points, to debt funds at 300 bps-400 bps, to equity businesses doing mezzanine and preferred equity at 1,000 bps-1,200 bps. There is a huge wall of capital, both in equity and credit. It is waiting on the sidelines, seeking entry points.”
He also expects new entrants: “A couple of US insurers are looking to create programmes and there are Canadian pension funds that are not in the credit space but want to be. There are some existing lenders that are ramping up their debt businesses.”
Fortwell’s Smith has also identified the trend: “We have received inward approaches from capital sources looking to get access to the debt market. Even before covid-19 there was appetite from global money houses to get an increased debt exposure. This crisis has only accelerated the appetite of these capital providers and investors.”
“We know there’s a wall of money out there. At a time when it is uncertain what will happen on the equity side of the business, debt is a logical place to be. I cannot see the debt markets drying up: pension payments are still being contributed, insurance premiums are still being paid, deposits are still going to the banks, so they need to get that money out of the door and working.”
Benjamin Davis, chief executive of UK lender Octopus Real Estate, believes institutional investors’ appetite for a variety of debt strategies will grow. “We can see institutional investors looking for alternative ways to gain exposure to the returns in commercial real estate. A corrective market is coming – this should not be feared by investors, but rather be viewed as an opportunity. If a business was well-capitalised and strategically viable before the pandemic, we believe it will likely continue to be so once normality starts to return, post-correction.”
Lenders’ willingness to finance emerging property sectors will increase:
According to CBRE data, office investment in Europe dropped 31 percent in 2020, compared with 2019, with hotels down 66 percent. In contrast, healthcare investment volumes increased by 13 percent, industrial by 7 percent, and multifamily by 6 percent. As the covid-19 crisis undermined previously reliable sectors, many investors have pivoted to parts of the market previously considered niche or alternative.
As a result, JLL’s Kavanau expects to see lenders become far more willing to finance the less mainstream property segments. He said: “We were recently advisors on a £50 million life sciences deal. We spoke to 40 lenders and got around 20 quotes. Usually, we would expect 10 percent of those approached to provide quotes. There is so much interest in these alternative sectors, particularly life sciences, but also data centres. Capital is seeking residential and logistics, but also alternatives as the other outlet.”
Octopus Real Estate’s Davis predicts the healthcare sector to attract more capital in 2021, particularly in the firm’s target market of the UK. “The case for more and better healthcare real estate in 2021 is clear. The UK’s population is ageing rapidly, and powerful demographic trends are driving long-term growth in demand for age-adjusted real estate. We’re seeing strong and growing demand, from investors and operators, as well as those approaching or at retirement age, for retirement communities to continue to be developed at pace.
“The pandemic has also demonstrated the need for high-quality care home facilities where residents can feel at home and be properly cared for, whatever the external environment brings. The fundamental supply and demand imbalances in the UK market remain and there’s an opportunity for investors to provide the capital required to ensure that much needed modern, purpose-built care homes are delivered.”
Caution will remain the watchword in 2021:
Although Kavanau acknowledged the volume of capital at managers’ disposal for a wide range of debt and equity strategies, he stressed that few in the lending market are taking undue risk due to the unpredictable market conditions caused by the pandemic.
“We are late cycle, we know there are black swan events like covid-19, so the lending community is appropriately selective, and we will continue to see that. In investment, super-core buildings are trading at record yields, which widen for core-plus. It’s similar in the credit space. Core deals get tremendous interest. If it’s in the middle, it gets interest, but it’s a lenders’ market. If it’s not a compelling deal, it’s really hard to get done, and we can expect this to continue into 2021.”
He added: “Even though capital is raised, it is there for calculated risks. Most lenders are taking smart risk. They will go up the capital stack, but for better buildings. Doing things way outside on the risk curve is very tough.”
Fortwell’s Smith agreed there will be continued caution in the lending market into 2021: “Lenders do not have the capital upside of an equity investor, so they are likely to carefully assess risk and could impact leverage and lending levels.”
He added: “Equity markets at the moment have a lot of hope built into them. The true impact of the unemployment and job losses is yet to come through fully. I do think there is pent up appetite to get deals done. Agents want to get deals done to earn fees. Fund managers have capital unused that they want to get out of the door. Vendors will be motivated to sell. So, there will be a bit of a bounce, but what 2021 looks like towards the backend is unclear.”
Kavanau pointed out that values for core assets are back above the last peak, after the initial shock of the pandemic. However, he added that there remains uncertainty around the value of some property: “Value-add is off 5 percent-15 percent. Opportunistic is in the eye of the beholder, so there is still price discovery. But the extent of the secondary and tertiary scarring from the covid-19 crisis in European economies will remain a huge question.”