Could the European commercial real estate finance market’s overwhelming weighting towards floating-rate loans, as opposed to fixed-rate facilities, be due a shift?
Commercial banks’ traditional dominance of Europe’s property lending space has resulted in most loans being pegged to a reference rate. This has enabled banks to match their own borrowings on the interbank market. In contrast, loans in the US are often priced according to a fixed rate of interest. This is due, in part, to the greater proportion of non-bank lenders in the market seeking fixed-income-type returns.
However, some in the European market expect to see greater borrower demand for fixed-rate real estate debt.
In a report published on 8 September, London-based real estate finance specialists at law firm White & Case said the phasing out of the London Interbank Offered Rate – the benchmark for many loans – will be a major factor. The law firm argued that the uncertainty triggered by the demise of LIBOR – possibly by the end of 2021 – and the additional costs that are likely to be incurred to amend loans agreed in reference to the benchmark would amplify the appeal of fixed-rate debt.
Alternatives to LIBOR, such as the Sterling Overnight Index Average, are being discussed throughout the world of finance. But there is little certainty there. Until a consensus is reached, the option of borrowing at a set rate in order to forecast costs will undoubtedly appeal to many.
Fixed-rate loans typically command higher initial pricing than those with floating rates as the lender prices in the risk of committing to the rate for the term of the facility. However, the lawyers at White & Case argued that growing competition between lenders in Europe’s real estate market was forcing overall pricing down and narrowing the differential between fixed- and floating-rate debt.
The report also highlighted factors borrowers would need to consider when opting for fixed-rate loans. Despite tighter pricing across the market, the authors noted that lenders’ willingness to provide fixed-rate loans will vary according to their individual funding models. However, the growing influence of non-bank lenders in Europe may result in a greater supply of fixed-rate debt, as managers of institutional capital aim to generate steady, fixed-income returns.
The lawyers at White & Case also highlighted factors to consider when structuring fixed-rate loans. Although break fee costs are relatively standardised in the floating-rate market, the approach varies between different types of lenders in the fixed-rate market. The lawyers also pointed out that bank lenders may obtain hedging when providing fixed-rate loans. This means borrowers and lenders need to be clear from the outset about the costs for which the borrower could be liable if such a hedge were unwound due to early repayment.
Not all lenders will be equally keen to issue fixed-rate loans, and some banks will continue to favour floating rates. However, in an increasingly competitive lending space, many debt providers are focusing on broadening their suites of lending products to better meet borrowers’ requirements.
Ultimately, a reduced reliance across Europe on floating rates may help to create a more stable real estate lending space. A Vision for Real Estate Finance in the UK, a cross-industry report published in 2014 whose authors were concerned with structural stability, stated that a more balanced split between fixed and floating rates would help create a more diverse lending market. Either way, the uncertainty over LIBOR’s impending demise is bound to encourage some on both sides of the lender-borrower nexus to explore the fixed-rate alternative.
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