German lenders persevere through troubled times

In response to covid-19, banks raised margins and lowered LTVs. But few expect their appetite for real estate lending to wane

Germany’s banks, which have struggled with low profits for years, are under increased pressure as the country deals with its most severe post-war recession. But despite the challenges of covid-19, property market sources believe they will remain keen to finance real estate.

The German commercial property sector has outperformed other European markets in part because of strong demand from domestic institutions. Consultancy Savills reported a total of €101 billion of investment in the 12 months to the end of June, up 33 percent on the previous 12-month period.

Michael Morgenroth
Michael Morgenroth

“Investment demand for German real estate is still strong, particularly given the amount of liquidity injected into the economy by the government,” says Michael Morgenroth, chief executive at Dusseldorf-based alternative lender Caerus Debt Investments. The fiscal package, including a €130 billion stimulus, outdid all other EU markets as well as the US and is credited with supporting the economy through the pandemic.

Real estate lending banks have generally chosen one of two strategies in response to covid: put deals on ice, or persevere, but hike up pricing. According to Frankfurt-based debt advisory BF.direkt, lending margins increased from an average of 131 basis points to 147bps during the second quarter, as funding costs rose. Oliver Sill, senior real estate director at Bavarian bank Bayern LB, reports higher margins on new transactions, though he calls this a “correction of an incredibly low level of pricing before covid”.

“Pricing definitely increased, particularly at the peak of the crisis, due to liquidity costs and as a market reaction of lenders,” adds Dirk Brandes, board member at Natixis Pfandbriefbank, the German arm of French banking group Natixis. “It went up roughly 30-50 bps.”

Brandes says lenders are also more cautious on leverage, with loan-to-values on average down by 10 percent.

“Transaction structures must reflect the risk inherent in transactions,” says Thomas Köntgen, deputy chief executive of pbb Deutsche Pfandbriefbank. He says his bank’s real estate loan portfolio now has leverage averaging 53 percent, with margins raised.

Although bankers will not want a return to ultra-low margins, some point out that banks’ funding costs have eased since June, with some reporting that loan margins have subsequently dropped back slightly. “The main reason for the [margin] increase was an increase in funding costs for lenders, which they passed on to the borrower,” says Morgenroth. Although activity levels vary among Germany’s banks, market observers agree there is a continued supply of finance to the country’s real estate borrowers. Real estate finance will remain a mainstay of banks’ commercial businesses, sources say, even if they tread more carefully for now.

Steffen Sebastian
Steffen Sebastian

Steffen Sebastian, professor of real estate finance at the International Real Estate Business School at Bavaria’s University of Regensburg, says banks are seeking remuneration for increased risk by raising their margins, and that they are favouring less risky asset classes: “Housing is still the most preferred sector. Hotel financing is currently difficult, and retail depends highly on the tenant mixture.”

Cautious return

Lenders that took a wait-and-see approach during lockdown are returning, albeit conservatively, says Björn Kunde, head of corporate finance and portfolio transactions at consultancy BNP Paribas Real Estate. Banks are being greeted with refinancing requests for core, defensive asset classes such as residential and logistics, which Kunde says are “low leveraged anyway with sufficient equity to fund these deals”.

The government’s fiscal support and the conservative use of debt in real estate in recent years are perhaps among the reasons borrowers in Germany do not seem to be struggling to service loans. Lenders tell us they have not had to take any enforcement action as a result of covid, with only minor covenant breaches reported.

Deutsche Hypo board member Andreas Rehfus says the bank has asked some borrowers to inject more equity into the loan structure: “Sometimes we accept waiver agreements or defer payments for a limited period.” Köntgen says pbb had seen “limited covid-19-related credit issues and no defaults”.

As banks exercise caution, some argue borrowers will turn to alternative lenders for finance. “The strong position of banks, which have become more and more aggressive in terms of high LTVs, pre-covid, made it difficult for non-bank lenders because margins are lower compared to other countries,” says Morgenroth. “Now banks are more defensive, opportunities will definitely open up for non-bank lenders.”

Alexander Oswatitsch
Alexander Oswatitsch

Alexander Oswatitsch, head of European real estate debt for asset manager DWS, adds that although banks have historically dominated Germany’s property lending market, institutional investors are increasingly keen to back real estate debt funds: “Post covid-19, they offer even more attractive pricing combined with structural capital protection, such as bespoke covenants.”

The growing appetite for managers of German institutional capital to invest in real estate debt was highlighted in May when Allianz Real Estate, the Munich-based insurer’s property investment arm, secured a $324 million mandate from Bavarian pension fund manager Bayerische Versorgungskammer to invest in property debt, albeit on a pan-European basis.

Alternative lenders

Foreign non-bank lenders have also found lending opportunities in Germany. In February, the UK’s M&G Investments issued a €168.3 million refinancing loan for a Berlin office campus. “The local lending market in Germany has always provided the majority of capital as they have always been able to price quite competitively,” says Isabelle Brennan, M&G’s real estate finance director. “Covid-19 could open the door for more alternative lenders who have a slightly higher appetite for risk and so more flexibility towards LTV levels.”

Yet the duration of any shift to alternative lenders remains in question. “We have more levers we can pull to strike the right balance for borrowers,” says Brennan. “But I suspect this is a more temporary opportunity during the pandemic rather than a long-term fundamental shift. I think local lenders will remain strong and well capitalised.”

Covid-related uncertainty has forced German lenders to pull back from parts of the market, opening a window for debt funds. Yet few of our sources expect banks to give up much market share.

With one of Europe’s lowest covid death rates and the biggest stimulus, hopes are high for a German economic bounce back, and real estate lending banks will take the lion’s share. “For both the investment and lending market, Germany is one of if not the most stable location in Europe,” says Kunde. “Alternative lenders fill a niche and they are highly welcomed – but I do not think they will ever substitute banks.”