Although there was plenty of debate at the PERE Debt and Finance Forum, held in London on 25-26 June, nobody questioned the assumption that we are late into the property cycle.
One implication of that, several panellists agreed, is that there is plenty of debt around. In addition to the supply of loans from the banks, investors are moving capital from private equity to private debt. This reflects a widely held perception that credit is a safer place to be when real estate values are at their peak.
Here are some of the issues discussed by panellists:
• Raising is easier than deploying: Although the underlying real estate cycle is far advanced, panellists argued that lending activity has remained disciplined this time round. With equity returns having dipped in recent years, investors have been lured towards debt strategies. The concern, one debt fund manager pointed out, is that lenders might not deploy that capital within sensible risk parameters at this late stage of the cycle.
• Debt strategies are adapting to demand: As more investors seek access to private credit, managers are offering them a wider range of products to fit their varied risk appetites. Just as real estate equity strategies have become more nuanced as underlying sectors of the property market have evolved, so too have debt strategies. One speaker noted the trend towards “capex-heavy” loans – hybrid investment/development facilities for properties in need of added value.
• Most property is financeable: Borrower panellists generally agreed that lenders in Europe are doing a pretty good job of providing loans where they are needed, though there are exceptions. The care home and senior living sector is one part of the market that borrowers felt was unlikely to grow without support from lenders, even though it is still generally regarded as a sound investment proposition. Development finance is available, panellists added, with speculative office construction loans on offer for those willing to pay for them.
• Lenders are getting their heads around operational real estate: At last year’s PERE Europe event, lenders openly pondered the risks of backing service-oriented real estate. A year on, it is widely accepted that what has traditionally been considered ‘core’ real estate is being repurposed on a more operational basis. More lenders, for instance, recognise the evolution of standard office leases towards a more flexible model.
• The diversity of lenders will soften the downturn: Panellists argued that the mix of lenders active in Europe today – compared with during the last cycle, when banks dominated – will stand the lending industry in good stead for the next downturn. This greater diversity makes a quicker recovery more likely, as risk will be spread among established debt fund managers and a more tightly regulated banking sector.
• Lenders are thinking about recourse: A hot topic, one transatlantic lender noted, is the lack of corporate and personal guarantees available to lenders in Europe when compared with the US, especially in development loans. Lenders are exploring measures to address this, such as borrowers being asked to offer letters of credit and increased contingencies in their development budgets.
• Borrowers are likely to be cut some slack: Panellists agreed that underwriting standards are being maintained and that there has not been a slide in the real estate lending space towards ‘covenant-lite’ loans. However, lenders indicated that they would take a sympathetic approach towards borrowers that were in danger of tripping loan-to-value covenants if the market turned against them. It seems that although lenders want borrowers to stick to their business plans, they will not be draconian on covenant breaches.
• A greater focus on sustainability is needed: Although some real estate lenders have shown it is possible to structure loans against sustainability benchmarks, there is still a lack of environmental, social and governance-related financial products in the property lending space. A lack of urgency and data in this area were cited as stumbling blocks. ESG in real estate finance is a recurring theme: some progress has been made, but nowhere near enough.
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