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Knight Frank: Loan distress is likely by the end of Q1 2021

Refinancing challenges in Europe’s property debt market could lead to more direct real estate sales in the coming 18-24 months, the consultant says.

Breaches of property loan terms by borrowers are likely to become more widespread in European markets by the end of the first quarter of 2021, following a prolonged period of forbearance by lenders, according to Knight Frank’s head of debt advisory.

Lisa Attenborough, a London-based partner with the consultancy firm, told Real Estate Capital that Europe’s banks have, so far, been encouraged by regulatory authorities to waiver loan covenant breaches, where the breach is due to “general market conditions”. As a result, there have been few distressed debt situations in Europe’s real estate loan markets due to the covid-19 crisis, to date.

Attenborough: “Wherever possible, lenders will look to restructure and recapitalise”

“We started to hear of banks making large provisions for bad debts back in July, but many borrowers have been given six to 12 months covenant testing holidays, so the situation is still unfolding,” Attenborough said.

“I think it is likely that we will start to see distress by the end of Q1 2021,” she added.

Attenborough believes the subsequent period of distress could “last for some time”. She said: “The exact length of time and extent of distress will very much depend on what measures are put in place to contain the virus in the coming months and the knock-on effect it will have on the UK.”

She added that the impact of loan market distress will be “wide reaching” across sectors, but suggested retail, hospitality and purpose-built student accommodation could be particularly affected. “Wherever possible, lenders will look to restructure and recapitalise,” Attenborough said. “However, this will not be possible for all asset classes.”

Knight Frank, in the latest edition of its annual Active Capital report, said the shock dealt by the pandemic to the leverage market is yet to feed through in a significant way to the commercial real estate sector. It said that, while Europe’s banks are already provisioning for losses and have experienced subdued equity performance, they have stronger balance sheets than during the 2007-08 global financial crisis.

Banks have been further bolstered by extensive fiscal, monetary and regulatory support, said Knight Frank capital markets research partner, Victoria Ormond. These measures include governments underwriting loans and the temporary reduction or removal of countercyclical capital buffers. In both the UK and Germany, the buffer is set at zero percent, increasing banks’ lending capacity by around 10 times what was lent in 2019, according to Ormond.

“However, in time, there will likely be more loans breaching covenants due to borrower circumstances. At this point, we may see more loan restructuring, enforcement and asset sales,” said Ormond. She added that borrowers’ difficulties refinancing loans secured against poorer-performing real estate may provide an impetus for more direct property transactions in the coming 18-24 months.