After years of benign market conditions, Europe’s real estate finance industry faces the prospect of a coronavirus-triggered downturn.
For those organisations that entered the lending business during the current cycle, this is the first real test of their loan books. For those that experienced the 2007-08 financial crisis, now is the time to get to grips with an entirely new and unprecedented threat.
As one real estate banker told us this week, it is too early to know how property loan pricing and structures will be affected. But with such capital markets dislocation, lenders will have to reassess risk across their portfolios.
Here are some early observations on how covid-19 will impact Europe’s real estate debt market.
The big picture – global recession looms
On 17 March, rating agency S&P Global said that as the pandemic escalates and growth heads sharply lower against a backdrop of volatile markets and growing credit stress, its economists were forecasting a global recession this year. For several years, lenders have acknowledged that they are operating in an unusually extended property cycle, and covid-19 seems to be the black swan that triggers the long-anticipated market correction. However, the crisis has prompted central bankers to cut already-low interest rates, meaning core real estate could remain a source of relative value for investors.
All property sectors face pain
Such is the disruption to everyday life caused by covid-19, it is difficult to think of a real estate sector that will not be hit. Rating agency DBRS Morningstar, in an update on three CMBS deals secured by 86 UK hotels, said the loans were likely to withstand a short-term decline in revenue but that a worsening scenario could lead to lower occupancy and cashflows. In a report published on 17 March, financial services group UBS said retail would underperform, as covid-19 accelerates structural challenges to the sector. It added that muted rental growth would affect offices and logistics, and that if there were rising unemployment rates, the residential sector could come under pressure.
Loan covenant breaches are likely
UBS also said that because retail is more leveraged than other sectors, more ‘motivated’ or distressed sales could be expected, which may exacerbate drops in valuation across the sector. Hotels, it added, are also more leveraged than other commercial real estate sectors. Most European real estate lenders have remained relatively conservative during the current cycle, with leverage typically low across the market. However, many loans have been written against top-of-the-market valuations, making them vulnerable to shifts in pricing.
Liquidity has already been hit
Blackstone, the world’s biggest private equity real estate firm – and a major borrower and lender in European real estate – warned that the coronavirus presents a material risk to its funds’ performance. Elsewhere, on 13 March, sister title PERE reported that New York-based real estate fund manager Madison International Realty had paused the deployment of its latest fund, for which it recently closed $1.2 billion of commitments. Institutional investors are taking stock too. On 17 March, Rainer Komenda, head of real estate funds at German pension giant Bayerische Versorgungskammer told PERE the company had imposed a moratorium of at least four to six weeks on real estate investment decisions. With dealflow down, new financing mandates will be scarce in the short term.
It is too early to take a clear view on covid-19’s long-term impact on European real estate finance. However, it is fair to say the crisis will force lenders to reassess their risk appetites and potentially refocus their loan portfolios. Just as covid-19 is affecting every aspect of life, so too will it affect how real estate is used. In the last couple of years, a huge emphasis has been placed on the changing dynamic between landlords and tenants, and this crisis will bring such issues into sharp focus. For instance, if companies maintain productivity with their staff working at home for long periods, they might question their longer-term office needs. Covid-19 just might change how property is viewed over the long term.
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