The cost of debt has continued to rise across Europe, while the looming refinancing gap weighs heavily on the minds of real estate investors and financiers alike. It is no wonder then that debt advisers and loan servicers are continuing to play a pivotal role in bridging the gap between lenders and borrowers while navigating these uncertain times.
The European real estate and debt capital markets, still reeling from the effects of a global pandemic and macroeconomic turmoil, are now facing further uncertainty brought on by myriad issues, not least of which is the rising cost of debt. But debt advisers and loan servicers across the continent, many of which are featured in Real Estate Capital Europe’s 2023 Debt Advisers Guide, say they see a path forward.
Rates continue to climb
This July, the European Central Bank announced a quarter-percent rate increase, marking a ninth consecutive interest rate hike in the eurozone. The bank said in a statement that inflation is “still expected to remain too high for too long”, despite the recent slowdown.
The rise brought the rate on main refinancing operations to 4.25 percent, the highest since October 2008. Just before the increase, inflation dropped slightly, to 5.5 percent in June, but was still far above the ECB’s target rate of 2 percent, according to reports.
Fluctuations in interest rates can affect the cost of borrowing and the attractiveness of real estate investments. Debt advisers and loan servicers can monitor interest rate trends and assess how rate changes could impact the profitability and viability of loan portfolios.
Rising interest rates have made bank lenders even more cautious and restrictive, limiting the availability of traditional financing sources, say many debt advisers. This has led to an increase in debt funds, insurance companies and other alternative lenders filling the gap, presenting a new set of opportunities across Europe.
Lenders, meanwhile, are seeing more stress in their portfolios as interest rates continue to climb. It is widely understood we have left behind the times of zero rates seen for much of the past 15 years, so borrowers and lenders must adapt to the new normal.
The higher cost of financing could lead to further asset repricing and the rise of non-performing loans – though that has not been seen yet, at least to the extent that occurred coming out of the global financial crisis. If interest rates rise even further, the effect that could have on real estate capital markets could be significant.
The looming refinancing gap
The availability of debt financing and its terms can impact the feasibility of real estate investments. Advisers should understand the lending landscape and how changes can affect clients’ ability to secure funding.
Recent bank failures will likely have an outsized impact on the US capital markets, but could have some spillover into European loans.
Construction financing also remains a particularly risky area of property finance on both sides of the Atlantic, and requires specialised know-how and lenders willing to take it on despite possible cost overruns and shortages in labour and materials. Even existing construction loans pose a problem, as many will need to be replaced with permanent financing in a very different rate environment.
The refinancing gap is concerning many in the industry. By the estimate of manager AEW, Germany, France and the UK face a €51 billion debt financing shortfall for the 2023-25 period, as lenders reduce the amount of leverage they are willing to provide.
Of particular concern is the timing, as a huge volume of debt is maturing during a period of rising interest rates and tightening lending standards. As the need for financing outpaces available credit, property owners, investors, lenders and the real estate market as a whole could potentially see more distressed sales, defaults and a further tightening of credit.
A balancing act
Increasing awareness of environmental sustainability and climate change has led to a growing emphasis on eco-friendly and energy-efficient real estate. Advisers might help clients consider these factors when evaluating financing opportunities that align with these changing preferences.
The issue of environmental, social and governance concerns, while long discussed, seems to be more prevalent and front of mind for lenders, which are increasingly concerned with the costs and risks associated with making a property ESG compliant.
Similarly, regulatory changes can significantly impact the investment landscape. Advisers will stay updated with evolving regulations related to transactions, lending practices and financial reporting, all of which can influence investment strategies and risk assessments. Germany has become an area of focus for its stricter regulations, while in Italy, regulations are proving harder to overcome for debt funds.
Increased oversight of financial institutions is changing the way lenders do business in Europe, and possibly for the better – regulatory scrutiny could be staving off a much worse crisis, more akin to the GFC, all the while compelling professionals to embrace new and better approaches to conducting business.
Technological advancements and proptech innovations are also reshaping the real estate financing industry. Advisers are able to assess the potential benefits and risks of adopting new technologies, such as using AI for property valuation, data collection and financial reporting.
“Change is an unwavering constant across industries, and the real estate financing markets are no exception,” says Cyril de Romance, founding partner at First Growth Real Estate & Finance.
“Continuously evolving technology like artificial intelligence is serving as a catalyst in propelling the industry into uncharted territories of possibility.”
Overall, allocating capital effectively across various real estate assets requires a deep understanding of risk and return profiles. Advisers are increasingly being called on to optimise portfolio performance and advise clients on the entire capital stack.
The economic environment is presenting new challenges and is making the market for new loan originations more complex as lenders become more cautious about underwriting, loan terms and debt exposure while they re-evaluate the loan positions they want to hold.
Economic uncertainty impacts all real estate investment decisions. Debt advisers and loan servicers are needed to help navigate these uncertainties and advise clients by making informed recommendations.