Real estate investment activity across Europe was subdued during the first quarter of 2019, resulting in a lack of price movement in most of the continent’s debt markets.
CBRE’s European Debt Map for Q1 showed that in 19 out of 20 markets examined there was no change in the typical loan-to-value ratios offered for senior lending on prime offices, which the consultancy uses as the basis for its analysis. The exception was Finland, where leverage edged down to 60 percent from 62.5 percent during the previous quarter.
Although lending margins remained static across 15 markets, the remaining five recorded declines. These included Amsterdam, where margins fell from 1.05 percent to 0.9 percent, making the city more competitive for borrowers than Paris and Frankfurt – and with a slightly higher average LTV. Milan, Warsaw and Brussels all experienced 10bps falls in margins, while Helsinki’s fell by 5bps.
Despite the lack of movement in margins across most European markets, the total cost of debt fell because of declining interest rates in all markets except Norway. CBRE uses the five-year swap rate as a proxy for the interest component of debt. This measure fell by around 20bps, making it the principal driver of the near-universal decline in overall debt costs during the quarter.
Although there was relatively little movement in senior office lending terms, an examination of the data over the past year highlights significant sector trends. Although in Q1 there was less of a change in pricing for retail and industrial than there was for offices – perhaps surprisingly, given the crisis in retail and the boom in logistics – the 12-month view revealed more pronounced trends.
CBRE plotted margin against LTV between Q1 2018 and Q1 2019 for offices, retail and industrial at the all-Europe level and by four groupings of countries. At the all-Europe level, offices and industrial experienced slight declines in terms of both margins and LTV. Margins for retail increased, despite LTV falling by more than the two other sectors. Retail debt became more expensive, despite office and industrial debt getting cheaper. And the amounts retail investors could borrow declined more substantially than the amounts available to investors in other sectors.
The ‘G7’ – comprising the largest markets – Scandinavia, and central and eastern European countries experienced declines in retail LTVs (by 2.5 percent, 4.4 percent and 3 percent, respectively). However, the ‘Rest of West’ countries – including Spain, Ireland and the Netherlands – bucked the trend. Within that group, margins increased by just 1bp, and LTVs increased by 1.1 percent. According to CBRE, this is likely to reflect greater pressure to lend in these countries and greater confidence in the resilience of retail markets in which e-commerce has had less of an impact.
STRONG RETURNS ATTRACT INVESTORS TO DEBT
Despite European commercial real estate investment volumes falling by 22 percent in Q1, there have been no signs of a slowdown in the lending market, writes Paul Coates, head of debt and structured finance at CBRE Capital Advisors. According to Cass Business School’s CRE lending report, property lending in the UK increased by 12 percent last year.
Furthermore, the strong risk-adjusted returns on debt, relative to prospective returns on equity, are attracting new capital into the market. In recent weeks, debt funds amounting to around €1 billion have been announced and there are an estimated €200 billion of debt opportunities annually. These new entrants are creating competitive pressure across sectors to lend against the best assets, which is resulting in keen pricing and aggressive terms.
However, the slowdown in investment volumes may cause lenders to take a more selective approach or wait for the short-term political noise to quieten down before re-entering the market. This in turn could lead to increased due diligence and more specific asset selection by lenders.
A reduction in investment volumes could also lead to a greater proportion of refinancing if vendors opt not to sell assets. This is likely to be especially prevalent in the retail sector, where borrowers are unwilling to inject further equity and where lenders are struggling to underwrite rents and values.
Although CBRE’s analysis provides a good basis for comparison across markets and is indicative of the current state of lending, no two situations are the same. Finding the right lender for the right type of financing is paramount.