It was clear during discussions with real estate debt specialists at the EXPO Real conference in Munich this week that they have concerns about their market.
On the face of it, the gathering of 46,000 property people on 7-9 October demonstrated that the European real estate sector continues to boom, more than a decade into its current cycle.
Indeed, debt professionals among them were keen to make the continued case for property lending strategies. But they were also quick to acknowledge that lending so far into an unusually extended cycle, with sky-high property prices, has its challenges. Here are three recurrent areas of discussion:
1. There is a growing disconnection between the investment and occupier markets.
The European Central Bank’s decision to resume quantitative easing has convinced many real estate finance professionals that interest rate hikes are an increasingly remote prospect. This, in turn, means yield-hungry investors will continue to pump capital into European real estate. One German banker expressed his unease; record low property yields are the result of a super-charged investment market, rather than an accurate reflection of indicators of underlying tenant demand, he said.
The eurozone economy has been flagging and there are fears of a German recession. The investment market, the banker said, is in danger of losing its connection to “real life”.
Another lender with a focus on prime assets argued that more equity is chasing fewer deals. With prime yields below 3 percent in some European cities, owners are more inclined to hold assets, rather than be forced to reinvest in expensive markets. The subsequent downward pressure on cap rates is worrying, the lender admitted.
2. Life is getting harder for real estate bankers in European markets.
While banks remain hungry for real estate loans, sources at EXPO said banks are taking an increasingly cautious approach, including edging back the leverage they are willing to provide. Some suggest this is partly due to concern about late-cycle conditions, but also due to banks getting their balance sheets to a size they are comfortable with ahead of the implementation of so-called Basel IV regulations from 2021.
Bankers at the fair insisted they will not lose their appetite for property lending, although several argued a higher cost of capital under the regulations will force them to raise loan margins from their current low levels.
Non-bank lenders at the event suggested caution in the banking sector will allow them to capture a greater share of the market. As sponsors require higher leverage to help them achieve ambitious returns targets, non-banks are most likely to grant them the loan-to-values they need.
But while one debt fund manager agreed raising capital is relatively easy due to strong investor demand, he warned that it is getting harder to find well-structured loan deals which fit investors’ risk-return profiles. It is a mistake to raise more than you can sensibly deploy, he added.
3. The most successful lenders will be those that understand changing real estate fundamentals.
One banker admitted it is getting harder to write five-year loans because it is difficult to predict the state of certain sectors that far into the future. Under-fire coworking giant WeWork was frequently cited as a case in point.
One lender argued the flexible office space industry will continue to grow in Europe, but sponsors and their debt providers will need to carefully consider the most robust business models; lending against assets with hotel-style management contracts to coworking operators, rather than long-term leases, would be the best approach according to the lender.
As debt providers look for value in the troubled retail sector and are faced with emerging asset classes, such as last-mile logistics, sensible lending decisions will require making sense of the societal changes underpinning asset classes and a focus on the merits and risks of individual locations. As one senior European banker told us at the event, there isn’t one single story for the whole real estate market.