Following a summer of worsening economic conditions across Europe, real estate lenders are facing a challenging autumn. Inflation and interest rates look set to continue to rise and recession looms in the UK and the eurozone.
However, there is a nuanced outlook from lenders, depending on their risk appetites, capital sources and target markets.
Market conditions mean debt providers have fewer transactions to finance. Preliminary data from Savills in July showed Q2 European investment activity was slightly below €60 billion, which the consultancy said was 10.5 percent down on the previous five-year average. Some also report falling asset prices.
“Some sellers are getting bid 10-15 percent below where they were expecting,” says Michael Shields, EMEA head of real estate debt at Dutch bank ING. “Some buyers accept the discount, and some pull the deal. Most buyers are leveraged, so with debt costs higher, they need the price to come down to hit their returns, and why would they drop their return targets when there is inflation?”
Shields has seen lending conditions change. “In recent months, our hit rate spiked, which makes me a bit concerned that we didn’t change pricing soon enough. Also, some of our normal syndication partners are saying, ‘If a deal is under 200 basis points, we aren’t interested as we have other deals to do.’
“We managed to get all our big underwrites syndicated, but I know there are lenders having issues selling down. I hear some banks are selling debt in the secondary markets at a discount, due to syndications they cannot move.”
Cyril Hoyaux, head of real estate debt at Paris-based AEW, says the manager, which provides senior debt, will aim to be opportunistic to find what it believes to be good transactions across the eurozone, across sectors. “I think it will be more difficult to find acquisition financing because we expect continental European investment volumes to be much lower than in 2021. But opportunities will come from refinancing.”
Hoyaux expects traditional bank lenders to reduce activity. “As usual during a crisis, there will be a flight to quality and safety from all lenders, but banks will focus on very core, stabilised transactions, meaning some sponsors will have refinancing issues.”
While lender caution is resulting in a reduced supply of debt, some non-bank lenders see higher loan pricing and less competition as an opportunity. Clark Coffee, head of European commercial real estate debt at US manager AllianceBernstein, says liquidity is “definitely more constrained” than 12 months ago but reports greater activity from alternative lenders.
As banks retrench further, more quality lending deals are on offer, he explains. “Are we more selective? One hundred percent. But we’re still seeing more interesting opportunities, even with a tighter filter, than we did six months ago.
“Yes, transaction volumes are down, and there is no greater market certainty than at the start of June, so we don’t expect people to come back to their desks post-summer with renewed conviction. But a lot of what we do as lenders is not driven by new acquisitions. There’s always refinancing required, and a lot of banks may not be there at the same terms and pricing as last time.”
The increasing likelihood of recession is a threat to lending markets, says Chris Bennett, head of the London branch of German lender DekaBank. But he believes economic growth is not the most immediate concern for many lenders. “Interest rates and inflation are the metrics that will initially be more concerning than GDP growth to many lenders, because of the immediate impact they have on investment markets.”
However, Bennett argues many European lending books should be cushioned from some of the impact of the troubled economic outlook by the prevalence of interest-rate hedging struck at historic rates. “Most lenders should be able to withstand a drop in rental income across their portfolios and still have a significant rental surplus, because most loans were written at far lower debt costs than we see today.”
Bennett says Deka’s UK business will continue to take an opportunistic view of new business for the remainder of this year. “All lenders need to be realistic. The drivers of real estate performance in the coming years will be impacted by economic and structural headwinds. Opportunities need to be viewed in that context, but it doesn’t mean there won’t be interesting opportunities to lend.”
Widespread distress is not expected, despite the recessionary environment. But lenders acknowledge new business will need to factor in worsened conditions.
“I think recession creates greater uncertainty around sponsors’ ability to deliver their business plans,” says Coffee. “But as a debt investor we can just make more conservative assumptions. We might offer lower proceeds but adjust our pricing so it is still relevant to investors. Or we might offer the same proceeds but charge more for it. As a lender our key job is to ensure that our loan basis is not impacted by business plan risk.”
Bennett argues that lenders’ surest way to protect future income is by financing sustainable assets, owned by experienced sponsors, in structurally sound sectors. “We’ve seen rental growth in sustainable assets we finance due to the shortage of product of this nature. So, even if there is yield slippage, the income of the asset may improve to the extent that the lender sees limited capital depreciation.”
While market observers report less liquidity, some lenders remain convinced of the continued opportunity to deploy capital. Shields says ING’s lending targets will not be reduced. “Not at all. But LTVs will get a bit lower, covenants a bit tighter, and pricing a bit higher.”