One of the key insights of London’s Bayes Business School’s mid-year report on UK commercial real estate lending, released in October, was that more than half of overall lending during the first six months of 2023 related to borrowers refinancing loans with existing lenders. Only 14 percent of origination was accounted for by refinancing deals in which there was a change of lender.
This situation is at odds with the expectation held by many in the market this time last year. Then, market participants believed the wide range of debt providers and loan products that had emerged in Europe since the global financial crisis would enable borrowers to get on with bridging the gap between banks’ ever-decreasing loan-to-value limits and upcoming loan maturities.
Plenty of private debt fund managers are primed to bridge what manager AEW estimates to be a €93 billion refinancing gap in six European markets alone. However, across European markets, debt sources say a limited volume of refinancing transactions are currently completing in which alternative capital managers are replacing maturing bank finance.
While a wide range of alternative debt capital exists for refinancing, structural changes in the real estate market are complicating borrowers’ ability to access it.
Some of those debt providers that are keen to lend but remain on the sidelines have observed refinancing being achieved in cases where banks have provided capital for straightforward assets – those with healthy cashflow and low leverage. For the rest – including loans against properties that have lost significant value, need substantial capex, or are in breach of covenants or default – finding solutions to the refinancing gap has barely begun.
“In theory there is plenty of debt finance available to fill in the refinancing gap, but it remains a theory”
Damien Giguet, Shift Capital
“In theory there is plenty of debt finance available to fill in the refinancing gap, but it remains a theory,”
says Damien Giguet, founder and chief executive of Paris-based debt advisor Shift Capital. “Many of the situations we see getting resolved are those in which senior lenders have secured equity from the existing borrowers rather than because of capital injections from alternative debt vehicles or preferred equity injections.”
Bayes’ figures hint at this, at least for the UK. There, domestic banks, which hold the largest share of the property loan book, increased origination by 3 percent compared with the same period in 2022. Meanwhile, ‘other lenders’, which includes debt fund managers, issued 36 percent less debt. Debt funds’ lending was also skewed towards acquisition financing, rather than refinancing. The figures suggest some alternative lenders are growing their loan books but there is not currently a widespread trend of those lenders refinancing maturing bank loans.
Alternative lenders identify several reasons for this. Fabio Barbaro, director of London-based private equity firm Zetland Investments – an alternative debt provider currently seeking lending opportunities in Europe – says the company is finding it hard to “see sustainable solutions” for the refinancing situations that have emerged, particularly during the first six months of this year.
“When borrowers are able to service debt at the higher cost of capital, even at lower valuations, those situations are getting refinanced. However, much of what we have seen in recent months was not salvageable then and the likelihood is there will still be no solution now, particularly when borrowers are holding onto valuations from 2022.”
He adds: “While many opportunities are coming across our desks, we have done a lot less [lending] than in previous years. Often, the implications of providing a loan at a realistic valuation would, in some instances, imply up to 50 percent mark-downs. This is not palatable for the borrowers, which often cannot inject equity, or senior lenders, which don’t want to take an impairment of their positions.”
“The fear is if you lend today, you might be catching a falling knife”
Damien Giguet, Shift Capital
But Barbaro has also observed that, when assets are brought to market and do not achieve asking prices, value expectations are not being adjusted accordingly. “After getting very low bids on an asset, participants take the view that it is an opportunistic bid and therefore not reflective of true values. As a result, some situations are taking much longer to adjust.”
Research released on 10 October by ratings agency Scope supports Barbaro’s views. With a focus on borrowers that have raised finance via the bond market in recent years, it warned that many debt-laden property companies will need to confront a “severe adjustment” in property prices to find refinancing solutions as they face mounting maturities. It also identified companies with high-quality assets and “good market access through sufficient scale” as being most likely to weather the refinancing challenge.
Alexandre Bretz, director at Starz Real Estate, an alternative debt provider focused on mid-market lending, has also seen limited refinancing opportunities this year: “I thought there would be a greater opportunity to bridge the refinancing gap than we have seen this year.
“We suspect senior banks were able to extend their current financing, perhaps temporarily, without requesting dramatic equity recapitalisations. We did provide some euro-for-euro refinancings at a higher LTV than banks were comfortable with, but we were expecting, and continue to expect a greater volume of similar opportunities in the coming years.”
Echoing Barbaro’s point, Bretz says sponsors are approaching Starz with “unrealistic views” on the value of their assets, preventing the lender from reaching a financing agreement: “Valuers are lowering values by 10 percent but on certain assets that should be between 25-30 percent, and that is not just down to interest rate rises but because of dramatic changes in the way real estate is used, in my view.”
“Valuers are lowering values by 10 percent but on certain assets that should be between 25-30 percent”
Alexandre Bretz, director at Starz Real Estate
In the case of the office sector, for example, changes in usage and occupier demand is impacting value and requiring capex. “We are specifically aiming to lend to borrowers which recognise the adjustments necessary to prepare properties for this new world,” Bretz adds.
Philippe Deloffre, managing director, real estate at ICG Real Estate – a debt fund manager that has been providing alternative real estate capital since the global financial crisis, also believes value creation is proving to be the most influential factor in attracting debt capital today. “Banks are supporting healthy situations but for the majority of assets there will need to be value growth driven by rental increases or repositioning and this capital will not be provided by the banks.
“For borrowers to attract capital, the asset quality, market fundamentals, the journey that asset has to stability and [its] ESG standards are key. Given the cost of funds is not lowering anytime soon, a quality asset means the income will become stable and able to honour the interest coverage ratio and, most importantly, meet liquidity in the capital markets.”
Every crisis is different and while a broader ecosystem now exists to address a shrinking bank lender market, lenders face unique problems. The speed at which the refinancing challenge will be resolved will not be dictated by want of debt capital. As Giguet says: “There is a liquidity issue for most situations. The problem is most lenders are expecting values to fall further and as it stands today, they don’t know when this will stop. The fear is if you lend today, you might be catching a falling knife. Interest rates have been priced into deals but what can’t be priced into a deal is the value.”