Debt market uncertainty is adding to core investors’ problems

Equity is committed and ready to invest in prime European property, but a lack of clarity on debt terms is an issue for investors.

Uncertainty over lenders’ willingness to provide large loans, and on what terms, is a significant problem faced by core real estate investors.

With debt markets harder to read, buyers’ ability to invest a sizeable equity component into prime deals will be more vital than ever in the coming months.

There is plenty of equity in the market, ready to be deployed. Capital raised for global real estate investment in 2019 hit a record high of $145.8 billion, up 9 percent from the previous year, according to data from Real Estate Capital’s research and analytics team.

However, while investors are poised to invest the capital they are sitting on, deal activity is slow, with covid-19 causing problems, including in the provision of debt.

According to research published by consultancy Savills on 15 May, there is a pricing mismatch in the market. Buyers are looking for a 5-10 percent ‘covid chip’ on pricing. But vendors have no immediate incentive to sell at reduced pricing and create for themselves a challenge to redeploy capital.

A shortage of investment transactions is making repricing difficult. Much of this stems from lenders pausing and showing caution in debt pricing for prime assets. In such an uncertain climate, banks are less willing to provide the usual volume of debt financing, on terms borrowers have got used to, making it harder for core investors to rely on obtaining the necessary finance.

Lenders will argue the market slowdown is about more than debt supply. Investors are also wary, with many pivoting away from core-plus and value-add opportunities into the core part of the market but finding limited purchase opportunities. The practicalities of doing deals have become far more difficult too, with due diligence complicated amid social distancing, also creating a barrier to activity.

Lending market uncertainty is undoubtedly part of the picture. Savills said lending rates have shot up – even doubling for some core German offices. However, margins on core property are expected to stabilise – possibly not to pre-covid-19 levels, but to a more predictable level.

Core lenders have also brought their loan-to-value ratios down, from around 65 percent to what could be the new normal of 55 percent, Savills said. In addition, more focus is being applied to existing tenant covenant strengths and income streams.

Although many lenders have taken a time out from new financings, sources say German banks and insurance companies, which favour prime real estate, remain eager to do business. As lockdowns lift, their lending activity will gradually return.

But for the time being, during the temporary dip in the availability of real estate debt, Europe’s prime property market may represent more of an opportunity for equity-rich institutions that had previously not been able to compete with their more leveraged competitors.

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