European commercial real estate investment activity was subdued in the first half of 2019. CBRE data show overall volumes were down 19 percent in H1 2019, year-on-year, to €120 billion. However, debt markets remained relatively active, with refinancing deals supplementing acquisition financing transactions.
CBRE’s European Debt Map for Q2 2019 showed that in nine out of 20 markets, margins declined during the first half of the year. Margins fell by 25 basis points in Milan, 15bps in Amsterdam and 10bps in Brussels. Margins fell in all five central and eastern European markets included in the analysis, meaning the average margin fell from 2.54 percent to 2.07 percent.
In the remaining markets, margins were static, with three exceptions: London saw a 20bps increase to 1.7 percent, Dublin was up 10bps to 1.4 percent and Oslo was up 25bps to 1.95 percent.
For most markets, movement in interest rates was the key driver of change in margins, CBRE said. The consultancy uses the five-year swap rate as the proxy for the interest component of debt. The euro, sterling, Swiss franc and Danish krone rates all fell during the first half of 2019, by 43bps, 40bps, 39bps, and 51bps, respectively, contributing to a lower overall cost of debt.
Typical loan-to-value ratios remained unchanged across most markets, although Helsinki and Budapest saw headline terms nudge down to 60 percent and 70 percent, respectively.
CBRE further explored the relationship between investment market performance and debt pricing, by comparing the shift in margins during the first half of 2019 with the decline or growth in investment volumes between H1 2018 and H1 2019 in each market. The firm found evidence of a causal relationship between investment performance and changes in loan pricing, with stronger investment markets generally experiencing a greater decline, or at least stability, in debt pricing.
The four most resilient investment markets in H1 2019, in relation to the H1 2018 benchmark, were Italy, which saw volumes increase 30 percent year-on-year, followed by France, Belgium and central and eastern Europe, where volumes remained flat.
Correspondingly, margins fell in central and eastern Europe by an average 47bps, with margins in Milan down 25bps, by 10bps in Brussels and flat in Paris.
Investment volumes were weakest in the UK and Spain, with both down 35 percent year-on-year.
CBRE noted that loan margins in the London market increased by 20bps during the period and remained flat in Madrid.
Expert analysis by Paul Coates, head of debt and structured finance at CBRE Capital Advisors
This year, we have seen a continued flow of capital into operational and alternative property sectors. European hotel investment increased by 5.3 percent in the 12 months to the end of Q2, while total investment across all asset classes in Europe fell by almost 8 percent during the same period. The flexible working boom and the impact of company voluntary arrangements in retail raise the question: is real estate shifting towards an operational focus?
If traditional long leases are becoming less prevalent, debt providers need to understand the possible implications for their underwriting risk. Investors are arguably underwriting those risks, and possibly moving up the risk curve, in a search for value. They are demonstrating that they are comfortable with managing and operating their assets.
At the same time, the cost of debt has remained largely stable across Europe. In Q2, margins declined in nine markets and remained stable in a further three. Only three markets saw margins rise. Loan-to-value ratios have remained flat in almost every market. Is this changing risk profile – together with increased political uncertainty, particularly in the UK – being factored into risk-adjusted debt returns?
With demand for debt remaining high and significant levels of capital being raised for deployment into real estate debt, pricing has been kept tight. As once ‘alternative’ asset classes come to the fore, and emerging and operational risks are assessed, lenders and borrowers need to invest in the skills and underwriting capability to make well-balanced, risk-adjusted returns in a competitive world.