Europe has entered an era of sustained higher inflation and, with it, a period of growing unease about the macroeconomic outlook. Forecasts abound of a recession later this year or in 2023, as consumers across the UK and Europe face a squeeze on household finances.
UK inflation soared to 9.4 percent in June, the highest rate since 1982. Meanwhile, the European Central Bank, which has been less forthcoming with interest rate rises than peers such as the US Federal Reserve or the Bank of England, took the surprising decision to hike the deposit rate by 50 basis points to 0 percent at its last meeting in July.
With the era of cheap and easy money seemingly over, the European real estate market is likely to encounter more expensive borrowing. In July, real estate consultancy Colliers reported that “economic uncertainty is beginning to impact investment activity in Europe’s commercial real estate market”, noting a slowdown in the UK, where investment volumes “slumped” to £10 billion (€11.8 billion) in the second quarter, down from £17 billion in the first quarter.
According to Colliers, Germany also saw “a rapid reversal from the optimism of the first quarter”. Nevertheless, the country recorded overall investment of €28.4 billion in the first half of 2022, the second-best half-year performance of the decade, painting a rather mixed picture.
Clarity and consistency
In such a challenging environment, borrowers may find they need to lean more heavily on the services and skills of their trusted real estate debt advisers. Paul Coates, head of debt advisory and structured finance, EMEA, at real estate services firm CBRE, says: “What we help clients with, predominantly, is navigating the depth and breadth of what is out there in the debt market.
“We are dealing with over 100 lenders across Europe. It is difficult for a borrower to have that sort of coverage and that breadth. Because we are in the market every day, we can give them the clarity to help them navigate that.”
The second part of a debt adviser’s role is to find the best lending partner for a client. “We also give clients confidence in their ability to close the deal and, if there is some more uncertainty in the market, to the extent you can give greater confidence in the debt part of the transaction, it gives vendors and purchasers more comfort,” adds Coates.
However, he insists the core principles of the role do not change, whatever part of the cycle the market is in.
Simon Mower, director, corporate finance, debt advisory at professional services firm KPMG, agrees: “In all markets, our role is to help our clients get financing that supports their medium- and long-term objectives. Whether that is in terms of helping them source capital for growth, development, acquisition of assets, or just refinancing.”
However, Mower points out that in today’s market, there is a need for more debt advice and support in a few specific areas.
“If I broke it out into three categories, one of them would be helping to make sure our clients are prepared for the questions they are going to face about the current environment,” says Mower. “The second one is helping them determine their strategy, tactics and timetable for the market.
“Then, the third one is making sure they know where to go and look for the right pockets of capital. Because, if you think about the last time we were in significant economic difficulty pre-covid – let’s call it 2008-10 – the market was a lot simpler. There were fewer counterparties – lots of banks, fewer credit funds.”
Spoilt for choice
The real estate debt landscape has changed markedly since the 2008-10 crisis, when the majority of the lending market comprised the incumbent banks. When there was a run on the banks, lending all but dried up.
In the aftermath of the crisis, Coates says European regulators adopted a strategy to increase diversity, “so that if one part of the market had a problem, potentially other parts of the market could step in”. The emergence of alternative and specialist real estate lenders and credit funds means that borrowers are now spoilt for choice.
Charlie Allanson, associate director, corporate finance, debt advisory at KPMG says: “There is typically a lender out there for a transaction… but in its own way, that creates more challenges for borrowers.”
“If you thnk about the last time we were in significant economic difficulty pre-covid – let’s call is 2008-10 – the market was a lot simpler”
Steering clients through the real estate lending market is where debt advisers can really prove their worth. “You will pretty much find at any point along the debt spectrum there will be a lender that will take on a situation,” says Mower. “It is a question of who it is at any point in time and how much it costs.
“A big part of our job is finding lenders that are suited to the situations as they arise, and helping our borrowers, frankly, navigate those lenders – understand who they are and how to build relationships with them.”
It’s just as critical as ever to have relationships on both sides, Allanson adds of the role of a debt adviser. “Quite often, we act as the bridge between those challenges and that is probably now more important than ever, as there are challenges out there that need to be thought through,” he says.
Rising interest rates have put an end to decades of cheap debt. But, crucially, the availability of debt has not yet been curtailed.
CBRE’s Coates is still seeing a “willingness to lend across all sectors”, adding “we’ve got £2 billion of London or UK office deals in the market today that are still progressing very well”.
Amy Griffiths, director, debt advisory, national capital markets at Colliers, says: “Unlike after the global financial crisis, there is still significant liquidity in the European debt markets, with banks starting to refocus on new business opportunities post-covid.
“Many funds are expanding their debt financing strategies to real estate, or looking to deploy capital raised during the pandemic, particularly investment loans where the uncertainty created by inflation is lower than for developments.”
She adds that lenders are becoming more focused on debt service ratios, as high inflation and uncertainty around increasing interest rates continue to drive the rise in the underlying cost of capital.
One particular area of preparation that debt advisers are likely to be more focused on with their clients, given the environment, is stress testing, or downside forecasts.
Allanson says that lenders have been “relatively relaxed” about potential borrowers providing a downside forecast scenario over the past few years, while there has been a supportive lending environment.
But, he warns, now that we are in “a tricky external environment”, this is one instance where their debt advice to clients is changing.
“A discussion we would have with our clients is to provide a well thought out and realistic downside case to a lender. Because you then protect yourself from the lenders creating them themselves and making it much worse than a realistic version might look,” Allanson explains.
Griffiths adds: “We are supporting our clients [to] navigate this new normal and obtain refinances through formulating and stress testing their business plans, and either presenting these to their existing lenders or, where they fall outside of their existing lender’s appetite, we are introducing them to new pools of capital.”
For Coates, it is all about lenders needing to feel “comfortable with the kind of client they are lending to for the next three [to] five years” when markets are more uncertain. For this reason, there will likely be more scrutiny on the borrower’s management team and their track record.
“In a difficult environment, the quality of the management team is increasingly important. We spend a lot of time, where you have got a great borrower management team, really positioning that as well as possible,” says Mower.
A team’s experience, demonstration of having solved challenges before and vision are the areas of focus for lenders, he notes.
Navigating ‘lumps and bumps’
Something yet to play out in the real estate sector is refinancing of debt, Coates observes – these have all been put on hold during the covid-19 pandemic.
“There is a pent-up level of debt that needs to be refinanced, just as a function of the loan [having] come to its natural maturity date. If we are to see the values of real estate move in response to interest rates, there is going to be potentially quite a lot of refinancing to do over the next year or two,” he explains.
“In the normalised UK market, you typically see about £50 billion of loans refinanced in any year. That could be significantly higher, or the demand could be significantly higher than that, potentially in the next year or two. How lenders respond to that volume of transactions and how they resource that will be quite interesting.”
KPMG’s Mower says: “My advice would be if there is anyone out there with a 2023 maturity – ie, they have debt maturing over the next 18 months – then they need to be thinking really hard and engaging with people about the strategy for refinancing it, because it may well be a really challenging period where having certainty is a material benefit.”
Despite the economic backdrop, there is still debt available in the European real estate market. However, accessing it might require more guidance and expertise than borrowers have needed over the past decade.
“We earn our money more in this sort of market than we do in more benign conditions,” Mower believes. “It is because your average transaction – which may have one or two lumps and bumps in it in a normal market – might have a lot more lumps and bumps in it as you are working through execution in a challenging environment.
“We spend a lot more time problem-solving and it requires more navigation than it does in an easier market.”