A new crisis is knocking at the door of Europe’s commercial real estate financing market – a shortfall between debt due to be repaid at maturity in the coming few years and the money available to repay it.

This refinancing gap is in the order of €24 billion in the UK, France and Germany for 2023-25, according to AEW. The Paris-based manager’s estimate looks modest against the €80 billion liquidity shortfall it said was faced in the UK alone following the global financial crisis. Regardless, it could cause “significant” refinancing issues for borrowers, according to Hans Vrensen, AEW’s managing director and head of European research and strategy.

Meanwhile, Nicole Lux, senior research fellow at London’s Bayes Business School, says in one potential scenario the UK alone faces a debt funding gap of at least £27 billion (€31 billion).

Lux estimates there is as much as £76 billion of debt – out of a total outstanding debt pile of £178 billion – which is in danger of falling short of interest payments and will require refinancing in the coming five years. Property values will need to fall 36 percent to meet lenders’ minimum interest coverage requirements, she calculated. That means lower loan-to-values for refinancing, making only £49 billion of new debt available to replace those existing loans.

Sponsors face the challenge of refinancing loans in an environment where banks are more likely to write senior facilities at 45 percent LTV than the 55-60 percent seen across the market at the start of the year. They also need to find lenders willing to invest in a falling market.

While this presents problems for borrowers, many in the property credit industry see it as an opportunity. There is confidence that the debt markets are better structured than in previous crises, with a healthier variety of capital providers, as well as better-capitalised banks that are less exposed to price falls.

“Are we better situated now? Probably, yes,” says Vrensen. “The infrastructure to work out troubled loans is still there, and banks have also stepped up their tier-one capital ratios and are better-positioned to deal with any writedowns when needed.”

Better equipped

Alternative lenders are expected to play a leading role, having raised vast amounts of capital for strategies ranging from senior lending to opportunistic debt. “Across the capital stack, everyone is better equipped,” says Martin Farinola, head of real estate debt strategies for Delancey, who is overseeing the growth of the UK real estate company’s mezzanine and senior debt business. He sees a decent mix of providers to suit a range of return expectations and “a growing acceptance of alternative lenders”.

But Lux is concerned there may not be enough finance for higher-risk positions, such as mezzanine loans. “My assumption is that property values reduce, and senior lenders will have enough appetite to lend again at 50 percent LTV because they have reduced their risk. So, for me, the gap will remain at the higher-risk end of the capital stack.

“In theory the debt funding gap isn’t that large and, on the face of it, the debt funds alone could plug it. But it will be liquidity for the low-risk portions of the capital stack,” Lux argues. “For me, the gap is the one that then remains around the higher-risk debt.”

She argues there is current supply of this type of capital in the UK of £1 billion annually. “The industry probably needs five times that amount,” she says.

INREV, the European body for investors in non-listed real estate, has 98 debt vehicles in its database, with a total target equity of €60.3 billion. Around 23 percent is for mixed strategies – both senior and subordinate loans – and just 13 percent is for subordinated debt only.

The future course of interest rate movements remains highly uncertain.

With that in mind, sources say some borrowers are exercising extension options in their current loans. Such options appeal to borrowers because rates may have come down by the time the extension expires, sources say.

Payam Yoseflavi, real estate finance partner at law firm Bryan Cave Leighton Paisner, reports lenders are also riding out the situation until volatility settles by allowing for existing extension options to be exercised, incorporating new extension options for future use, or providing new loan extensions.

Yoseflavi says: “Lenders are quite keen to wait for the next round of valuations and at that point there will be discussions with borrowers about how they will comply with their loan obligations, perhaps asking for them to put in more equity, or provide deposits in accounts to remedy positions. If borrowers can do this, then lenders will be more amenable to refinancing.”

Higher debt costs and less competition is tempting alternative lenders into the senior space. “Due to the increase in interest rates, we are seeing increasing returns, and those are at lower LTV now,” says Farinola.

In May, Frankfurt-based DWS raised €150 million for junior lending, targeting “high single-digit” returns with average LTVs of 75 percent. But a little more than six months on, Alexander Oswatitsch, DWS’s head of real estate debt in Europe sees a “great opportunity opening up” for junior debt funds to go into stretch senior positions at lower LTVs. “This is lower risk and offers attractive margins in line with our funds’ target return,” he says.

While this may mean less appetite for high-leverage lending, sponsors in need of senior debt will have more options – albeit at a price.

Matthew Murray, director of loan servicing at loan management firm Mount Street, has also seen alternative lenders look at refinancing assets which would not have generated their target returns until recently. “But it is whether or not borrowers can stomach the terms because the pricing is, and will be, dramatically different. We are talking about material differences in rates. Borrowers might not have an option. Some may be pushed towards alternative lenders.”

Uneven playing field

A defining factor in whether borrowers secure refinancing may be the quality of their assets. Lenders are more focused on financing assets they believe will meet occupiers’ changing needs, as well as more stringent sustainability standards. Alternative lenders are geared up to finance transitional real estate, but sponsors will need to demonstrate viable business plans to get their attention.

Peter Hansell, senior director of real estate debt strategies in Europe at investment manager Nuveen, says his firm is focused on lending against assets that offer “future value” when approaching refinancing situations.

“The challenge that we all have is really understanding, or trying to layer in, what the impact over the next 12 to 24 months will be of recession,” he says. “Do we end up in a situation where we do start to have corporate defaults, for instance? It feels as though it would be unlikely that we don’t, and therefore, to what extent does that impact occupier demand? That has a potential further impact on property values.”

Iryna Pylypchuk, INREV’s director of research and market information, believes not every sponsor will attract capital. “The debt funding gap is not a uniform proposition. Therefore, it is difficult to conclude that there is enough capital to meet the need. Some debt funds will look at a particular opportunity and decide it suits their risk-return profile, but some won’t touch it.”

Sectors are expected to be affected unevenly. For example, AEW estimates retail, which has had a troubled few years, will account for nearly 60 percent of the UK, France and Germany’s total 2023-25 debt funding gap, with a refinancing need of €14.3 billion.

Meanwhile, Lux says one analysis shows UK offices could need £21 billion of fresh additional financing, based on a 44 percent value decline across the sector in the coming five years. But as well as secondary assets with high vacancy, prime assets which were purchased at high prices relative to their rental income could also be affected, if income is not sufficient to cover increased debt costs.

“It is crazy to think that super-core assets could be the hardest hit in the refinancing challenge but if you have an all-in interest cost going up from 1 to 4 percent, it will have a major impact,” says Maud Visschedijk, head of equity, debt and structured finance at consultant Cushman & Wakefield, based in Amsterdam.

Income factor

Cashflow concerns among lenders will also be heavily influential in sponsors’ ability to secure new finance. Debt service coverage ratios will play a crucial role in lending decisions. With all-in debt costs up to around 6 percent for senior loans, sources say lenders are looking for DSCRs of at least 1.5x, which informs the amount of leverage they will provide.

As underlying occupier markets grapple with recessionary conditions, borrowers will need to work hard to convince lenders they can meet their repayments. According to Bayes, interest coverage ratios are falling below 1x across key sectors, and as low as 0.7x for prime logistics.

Debt yield ratios, dividing net operating income by loan amount, will also be important, says Mount Street’s Murray. “With other metrics, such as LTV or backwards looking ICR, distress might not be immediately apparent. But debt yield reveals what a borrower actually received in net operating income for a given period. It is why lenders are looking at this very carefully because they want to know now where tenants are under pressure.”

Hansell argues alternative lenders are adept at allowing for sponsors to asset manage to improve rental growth. “Everybody’s looking for cashflow and there being enough of that in the deal,” he says.

“Alternative lenders are more used to working with a reduced cashflow for a certain period of time, more so than the banks. But if the future is less certain, then that becomes a bigger question mark. And that will add to the cost of the loan in total, so that makes it even more difficult to get it done. It has got to be good deal, with a good amount of equity in order for it to work.”

Sponsors seeking refinancing may find lenders more stringent on loan terms, sources say.

Some are said to be more focused on ensuring surplus cashflow is diverted to keep borrowers in line with interest covenants.

Oswatitsch explains that DWS can put in place tighter cash-trap covenants than 12 months ago. “We are in an uncertain [economic] situation, and cashflow could deteriorate much quicker. You need to trap cash to reduce risk.”

In October, Harrison Street secured a £70 million refinancing from Deutsche Bank for a 325-home build-to-rent scheme in Liverpool. Miller sees lender attitudes changing across the market: “In some cases, lenders are giving relief on the ICR but are being more stringent over cash-traps and other credit enhancements to provide additional credit support.”

More equity

Due to the gap in debt funding, a greater role for equity is expected across the market. However, few expect to see cash-rich buyers swooping in to pay the prices current owners need in order to repay debt and protect their own equity. “They may only be prepared to support current values for properties high on their wish list. For everything else, they will demand a discount,” says Visschedijk.

She adds that equity investors are being inundated with proposals to invest in assets at current values. “They also see what is happening in the market, and they are not going to pay 3.5 percent yields when no-one else is.”

Hanno Kowalski, managing partner of Berlin-based advisory firm FAP Invest, agrees equity capital is not prepared to invest because valuations do not yet reflect market conditions. “This kind of capital will only come in when the price makes sense, and they will choose the most profitable projects when they do invest. This is why we see a lot of developments getting cancelled. So there will be defaults, there will be non-performing loans. Not everyone’s problems can be solved, and it will take time.”

In lieu of buyers willing to meet sellers’ expectations, the coming months are likely to see some owners secure fresh debt at lower LTVs and add more of their own equity into deals, putting pressure on their returns. Alternatively, some may seek to secure equity investors, either to invest alongside the sponsor in common equity positions – via joint venture partnerships, for instance – or through preferred equity investments.

Joint venture equity investors take a position in the riskiest part of the capital stack, with no cap on their return potential, while preferred equity typically operates similarly to subordinate debt, with the investor receiving a fixed return without any share of the profits but with enhanced rights to take over the asset in the event of a default.

“There will be investors prepared to take a view on an asset, but they may look to be in front of the existing equity and take a preferred equity return position,” says AEW’s Vrensen. “It might be hard for the existing equity to accept lower than previously planned returns. But at least with a new preferred equity partner they can limit any losses that they suffer, and that is also important.”

Chicago-based investment manager Harrison Street sees attractive “special situations” opportunities in the coming months, says Josh Miller, managing director and head of transactions for Europe. “Harrison Street can structure investments as preferred equity or debt, perhaps on developments where the borrower doesn’t have a strong enough balance sheet to pay down the principal in a challenging credit market. We can help solve those problems and provide a good outcome to the original investor while also potentially adding a long-term partner who we can help finance going forward.”

An enhanced role for various types of equity suggests a recalibration of Europe’s real estate financing market, as users of debt adapt to using lower leverage, at a higher cost. In the coming months, many borrowers will face challenges as they are forced to replace loans provided when debt was cheap and easily available, in a market in which it is more expensive and lenders are more discerning, albeit well-capitalised.

Crucially, market participants do not expect a liquidity crisis as was seen in the wake of the GFC. For capital providers, the debt funding gap has the potential to create a spectrum of financing situations. As INREV’s Pylypchuk argues: “The debt markets evolved owing to opportunity, and that opportunity is now growing. But this time around, the cost of debt is significantly higher, and this dynamic is unlikely to change for a long time.”


AEW took three years’ of acquisition volume data, beginning in 2018, split by sectors in the UK, France and Germany.

It calculated likely value changes over the loan term when related debt matures in 2023-25. Applying in-house loan-to-value data, it forecast likely leverage available across the various components and locations of the sample available to refinance at loan maturity, estimating a €24 billion aggregate shortfall. Meanwhile, Bayes estimated how much of the UK’s outstanding debt is expected to breach interest covenants. It calculated minimum ICR of 1.3x is achieved with a 36 percent fall in values. It concluded £49 billion (€56 billion) of an affected £76 billion will be refinanced in the next five years.