Europe’s commercial real estate lenders are facing the most serious threat of loan covenant breaches since the global financial crisis.

The problem is in the retail property segment and, for the time being, in the UK. However, the same factors shaping events there will likely have an impact on continental European real estate markets.

It comes down to the way we buy things these days, often by a tap on a phone screen. The advent of e-commerce has, frankly, left many operators of bricks-and-mortar shops looking out of kilter with the times. Many physical stores have been exposed as uninspiring places to visit as the online shopping alternative has improved.

The subsequent drop in footfall and the wave of retailer administrations have hit the value of UK high street shop units and shopping centres. CBRE data show a 10.5 percent fall in UK shopping centre values during 2018. Few in the market are able, or willing, to guess where values will eventually settle. It is highly likely loan-to-value covenants have been tripped across the market.

Although the financial crisis happened a decade ago, it remains etched into the memories of real estate debt specialists. Nobody wants a return to the days of banks seizing properties and selling them off in fire sales. To avoid that, it is essential lenders and borrowers work together wherever possible to find a solution for struggling retail assets.

For lenders, that might mean living with LTV breaches while sponsors work to defend or improve their properties’ income streams. For borrowers, it means showing lenders serious business plans to reposition assets as places shoppers want to visit and investing the necessary capital.

Where properties simply do not have a viable future as retail, more drastic plans for change of use may be necessary. Many shopping streets or centres were once the hearts of their communities and realigning their offer to make them attractive again is the only way forward.

Looking ahead, plenty of property in the retail sector will require fresh finance in the coming years. Banks and alternative debt providers must decide what type of retail property they are prepared to lend against. As market participants frequently point out, retail is not dead; boring retail is dead.

The shopping scheme of the future is not a row of identikit stores. It is a place people will want to spend time, and that is likely to require a mix of uses. Leisure space is the most obvious, while workspace and even living space could also breath life into retail destinations.

As retail values fall, a new generation of owners is bound to emerge; lenders should back those with innovative plans, perhaps executed in collaboration with local authorities. In an upcoming feature, we will take an in-depth look at how lenders are reacting to the retail crisis and whether parts of the sector are in danger of a debt drought.

The viability of vast swathes of the retail sector will be keeping lenders awake at night, but debt will play an important role as the sector is reimagined in the years ahead.

Email the author: daniel.c@peimedia.com