AEW revises debt funding gap forecast to €93bn

The manager has expanded the geographic scope and timeframe of its previous analysis in its latest estimate.

Europe’s key real estate markets face a €93 billion debt funding gap in the 2023-26 period, according to AEW, which has expanded the scope of its analysis since publishing its previous estimate in January.

The real estate investment manager said the figure represents the shortfall between the volume of secured commercial real estate debt originated in the 2018-21 period and the amount likely to be available for refinancing at loan maturity in the years ahead.

The latest estimate is significantly larger than that published by the company in January. Then, AEW estimated a €51 billion refinancing shortfall for the original, more limited scope of the UK, France, and Germany – during 2023-25. The forecast was calculated in reference to the amount of leverage lenders could be expected to make available to borrowers in the coming years, as well as the impact of lower interest coverage ratios on the amount of refinancing capital lenders will extend.

The January research was itself updated from AEW’s initial analysis of the debt funding gap, published in September 2022, which at €24 billion was limited to the impact of lower LTVs.

Hans Vrensen, head of research and strategy at AEW, told Real Estate Capital Europe the latest cumulative figure cannot be compared directly with the previous estimates. The latest analysis was expanded to include three markets – the Netherlands, Italy, and Spain. However, the biggest change was driven by AEW’s decision to expand the timeframe of the analysis to account for loan extensions agreed between lenders and borrowers this year.

“We increased the coverage geographically due to requests from within those markets to do so,” explained Vrensen. “But the decision to extent the analysis by vintage was different. We have kept 2023 in the analysis – as well as expanding it to 2026 – because we don’t believe loans originated in 2018 have really all been refinanced in the typical manner this year. Rather than new loans being originated, many existing loans have been extended.”

Vrensen does not believe we are seeing as repeat of the ‘extend-and-pretend’ witnessed in the wake of the 2007-08 global financial crisis, however. “Lenders are extending for one or two years, keeping the existing structure in place, including the LTV. But given that rates have moved up, lenders are resetting the interest rates by requiring a new interest rate swap or cap be bought at loan extension. That is the big difference from the GFC.”

AEW’s latest calculations factor loans originated in 2018-21 into the analysis, to cover the refinancing period to the end of 2026, but with debt due to mature in 2023 retained in the analysis.

Germany is the most affected country, accounting for €36 billion, or 38 percent of the debt funding gap, followed by France and the UK, which each account for €19 billion. The Netherlands, Italy, and Spain account for only around 21 percent of the gap, with an aggregate €20 billion. By sector, AEW said offices account for the largest component of the gap at €39 billion, followed by retail at €25 billion, residential at €22 billion and industrial with €7 billion.

Vrensen remains of the belief the debt funding gap will be bridged by a combination of new equity, senior loan extensions, restructurings, and junior debt insertions.

“The industry is working tremendously hard in the background to restructure loans and get new and/or additional capital sources involved,” he said. “All this takes dedicated work and time because there will always be a disagreement between new capital that needs to come in and old capital because old capital might not be ready to accept its losses or loss of seniority. None of this is easy but it’s not a system-wide banking problem.”

Potential losses

AEW has used its analysis to examine potential losses on commercial real estate loans across Europe in the coming years. The manager assumed defaults for loans across sectors and vintages with an LTV at refinancing of more than 75 percent. It estimated 5.8 percent of total loans originated in 2018-21 will default at maturity, with expected losses at 2.2 percent of the principal loan amount after adjusting for enforcement costs.

Vrensen explained this is in line with historical post-GFC European commercial mortgage-backed securities losses, and added that losses are likely to be concentrated in loans with retail collateral. “We posed the question: does Europe have a systemic banking issue? Based on our analysis, we think that it probably does not,” he said.

He added European Banking Authority data also shows European banks have sufficient reserves to absorb such a volume of potential losses, meaning commercial real estate loans “should not present a systemic risk to European banking in the current cycle”.

In addition, AEW said all-in borrowing costs have “started to stabilise”, despite having reached a 20-year high in Europe, more than doubling in 18 months to 5.9 percent at mid-year 2023. It said stabilisation in debt costs “follows successive rate hikes by the European Central Bank and the Bank of England, which have started to bring down inflation”.

AEW expects LTVs to stabilise at 50 percent by the end of 2023. In its report, it added: “Declining collateral values and lower LTVs, amplified by the higher interest rate environment, are likely to trigger significant refinancing challenges for existing legacy loans … at loan maturity in 2023-25.”