Tom Barrack, real estate magnate and friend of US president Donald Trump, believes his country’s commercial mortgage market is on the brink of collapse due to the covid-19 crisis.
In a white paper published on 22 March, and in subsequent TV interviews, the chairman and chief executive of private real estate manager Colony Capital – itself a lender – said $16 trillion of commercial real estate loans are facing a temporary meltdown in cashflows.
He argued that complex funding agreements – whereby banks, through repurchase arrangements, buy loans originated by debt funds and mortgage REITs – will make it difficult for the latter lenders to give their borrowers breathing room when they run into trouble. As banks are required by regulators to periodically ‘mark to market’ the loans or commercial mortgage-backed securities they are financing, non-banks are required to satisfy the resulting margin calls to cover possible losses.
Barrack’s proposed solution is for banks and alternative lenders to agree a collaborative effort to avoid margin calls and for regulators to temporarily waive mark-to-market requirements. In a nutshell, he said a time-out is needed to avert a credit crisis.
The specifics of Barrack’s argument pertain to the US market, with its diverse and intertwined lender mix and highly active securitisation market. Things are different in Europe, where banks and non-banks have largely separate sources of funding and CMBS is a small part of the picture.
However, property lenders in Europe should take note of Barrack’s wake-up call. A coronavirus-induced real estate credit crisis in the US would have serious implications for European markets. US capital, both equity and debt, is a major component of the continent’s real estate markets and a pull-back would have a major ripple effect.
Barrack’s warning about borrowers’ widespread inability to service their debt across several property segments is also highly relevant. The extent of the impact of the covid-19 crisis on European lenders’ portfolios cannot yet be known. But with quarterly rental payments looming, followed by scheduled interest payments, the scale of borrowers’ troubles will become clear in the coming weeks.
In the last couple of years, European lenders have had their first taste of dealing with loan covenant breaches during the current cycle. The malaise of the retail sector has forced many lenders and borrowers to the negotiating table to resolve situations where loan terms have been infringed but both sides believe in the long-term viability of the underlying assets. Lenders now face the prospect of breaches on loans across several sectors in deals that were, until recently, built on solid economic fundamentals.
Speaking about the US market, Barrack said it is imperative that real estate lenders are not forced by their financing sources to meet their borrowers with rigidity during this time of heightened need. The European real estate finance executives we have spoken to in the last week have echoed the sentiment: collaboration between lenders and borrowers is going to be crucial in the coming months.
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The coronavirus crisis has thrown Europe’s real estate lending market into disarray. All of Real Estate Capital’s covid-19 stories can be found on this page.