Financial markets volatility puts pressure on property debt costs

Movement in swap rates is contributing to higher total debt costs for borrowers. Jackie Bowie, head of European real estate at risk management firm Chatham Financial, says potential interest rate increases by the European Central Bank are priced into the Euribor swap rate. “The short end of the Euribor curve is steep, and the market expects an end to negative rates in the next two months. The substantial increase has taken some borrowers by surprise.”

In the sterling loans market, Bowie also notes a steep forward curve on swap rates, with the Bank of England rate rises priced in. “The question for the sterling market is, has the market baked in too much of an increase, and will we see a plateau after the summer given the slowdown in the economy? We might see some borrowers decide not to fix rates now, and stick with the floating SONIA rate, which is 0.62 percent versus fixing at the much higher three-year swap of 2.15 percent.”

Lenders are reported to have raised loan margins. Francesca Galante, founding partner at pan-European debt adviser First Growth Real Estate, agreed pricing in January for a loan for a borrower client which closed in mid-May. She notes financing costs – comprising liquidity costs and swap rates – changed significantly during that period.

“The seven-year swap rate moved around 145 basis points. If we had not locked in the liquidity cost, the loan margin for that deal – which is a super-core, 45 percent loan-to-value deal – would have increased by 20-30 percent, with the lenders involved,” she says.

Claus Skrumsager, who runs the North Haven Secured Private Credit Fund for the asset management arm of US bank Morgan Stanley, has also seen price movement: “Some of the very tightly priced logistics and residential propositions, previously in the 100-150bps range, and 60 percent loan-to-value, have seen 25-50bps added to the price, and the LTV reduce to below 60 percent. Spread widening is not dramatic. It is nowhere near the doubling in spreads in the iTraxx [credit derivatives] index, but it has been in the order of 10 to 20 percent so far.”

Margin call

Chatham Financial recorded a 10bps overall increase in the margins being charged to real estate loans in Europe during Q1. Bowie expects to see a similar increase reflected in end-Q2 data. “Lenders require higher returns for the increased credit risk they are taking,” she says.

Bowie adds higher base rates, rising margins, and the costs of interest rate caps and swaps is likely to dissuade some from concluding financing deals. “My intuition is we’ll see a quieter few months through the summer with some deals on ice, and people delaying refinancing.”

In another indication of financial volatility impacting the European real estate debt market, commercial mortgage-backed securities issuance has been slow so far this year. In the primary CMBS market in Europe, Trepp noted AAA spreads ranging from 65bps to 150bps in 2021, with the lowest price seen last summer. So far this year, it has seen three transactions price, with spreads ranging from 130-145bps.

In May, per a person familiar with the matter, UK bank HSBC pulled a planned £380 million (€447 million) student housing CMBS.

Euan Gatfield, managing director and CMBS analyst at rating agency Fitch, says secondary market bid-offer spreads have widened due to asset-backed securities investors’ reluctance to buy notes at a time when they need to remain liquid in case investors in their funds seek to redeem capital. “That makes it very difficult to price new issuances,” he says. “CMBS pricing has widened, particularly for sub-investment grade tranches.”