Commercial real estate market conditions in Europe will test incumbent lenders’ ability to extend or replace maturing loans in the coming months and years, and property debt specialists believe this will create refinancing challenges for sponsors, and opportunities for active credit providers.
During a panel discussion at industry body CREFC Europe’s Spring Conference in London on 23 May, moderator Madeleine Cosgrave, non-executive director at property investor and developer Landsec, asked panellists whether lenders are likely to extend loans as they expire.
“We know 2024 will be a massive refinancing year because Europe is predominantly a five-year, floating-rate loan market, and there was a lot of origination in 2019,” said Rob Weinberg, co-head of European real estate financing at real estate advisory firm Eastdil Secured.
“One significant issue is base rates. In many cases, they were zero looking back, and they are now 3 percent to 4 percent for the eurozone and the UK. Margins are relatively static because they are slower to adapt. Borrowers were using financing as an accretive tool for several years but that’s no longer the case.”
Current interest coverage ratios are closer to 1.5x in today’s market, from 2.0x-plus in recent years, added Weinberg. This means senior leverage might be capped at sub-50 percent, whereas senior lenders might have provided up to 60 percent loan-to-value facilities prior to last year’s steep interest rate rises.
This, added Weinberg, will cause stress for some borrowers. “There are loans that banks cannot refinance today without the sponsor putting in equity or buying hedging, which is expensive. In many cases, banks will work with sponsors constructively to find a solution. But there will be instances where sponsors will not want to inject fresh equity, and in those cases, even well-known sponsors will hand over the keys or work with banks in other ways.”
Next year is set to be a significant one for refinancing activity. In January, investment manager AEW estimated the debt funding gap for the UK, France and Germany to be €51 billion for 2023-25, as rising loan-to-value rates and lower interest coverage ratios (ICR) discourage existing lenders to write new loans to their borrowers.
Panellists discussed the likely differences between lender attitudes to loan covenant breaches and loan extensions in today’s market and during the covid-19 crisis. In 2020 and into 2021, lenders overlooked ICR breaches due to the pandemic’s impact on income across the property sector, and typically waived covenants and extended loans. However, interest rates have caused a correction in property values, meaning banks will be forced to carefully consider the amount of leverage in their portfolio and the volume of regulatory capital they will be required to hold against it.
Jonathan Haas, director at RBC Real Estate Capital Partners, the property business of Canadian lender Royal Bank of Canada, said the refinancing challenge will impact alternative lenders as well as banks. “A lot of these debt funds, mortgage REITs etc have business models that came out of the global financial crisis and have not been through a cycle like this before, so a lot of their thesis is unproven.
“The bigger funds, who have the ability to say ‘we can own an asset on this basis’, will have a team set up to handle that. Smaller funds just aren’t currently set up to deal with widespread amounts of distress.”
Tal Lev-Ari – managing director, Europe, at manager CIM Group, which counts lending among its activities – argued that the strategy of most debt fund lenders is not loan-to-own strategies. “CIM focuses on financing top-tier sponsors that bring management expertise to a business plan. The same way of working will be true in refinancing situations.
“We work with sponsors to see how the refinancing gap can be plugged, typically with additional sponsor equity, mezzanine, preferred equity, or a combination of these. Lenders will want to see what sponsors can bring to the table.”
In situations where lenders and borrowers cannot agree on refinancing terms, Eastdil’s Weinberg expects to see orderly sales of loans. “In those cases, there will be short sales, as opposed to mass non-performing loan sales, in which lenders will sell loans on a consensual basis with the sponsor for the highest price. That is what is prevalent in the US market.
“There will be sponsors that decide it doesn’t make sense financially to support a loan. The good news is there are many active lenders out there trying to plug the financing gap.”
Despite the challenges facing Europe’s real estate lending market, panellists were confident in a continued flow of credit to the sector. Landsec’s Cosgrave acknowledged tougher fundraising market conditions, although Weinberg said appetite for credit is growing.
“It’s rare to have a meeting with an equity market player that says they are not interested in credit,” said Weinberg. “Debt is a very appropriate instrument in a market where values are falling. Having said that, it can fall between real estate and fixed income in some investors’ organisations, and the denominator effect has made real estate capital raising more difficult.”
Overall, Weinberg argues Europe benefits from a functioning real estate credit market, especially when compared with the US currently. “In the US, there is real stress to the point that trying to finance even grade A office is incredibly challenging. We know what happens in the US often comes to Europe, so there is risk and [there is] the prospect of lending conditions getting tighter as US lenders need to provision for their loans.”
Cosgrave asked panellists if real estate debt represents good value in today’s market. RBC RECP’s Haas believes it is. “Sovereign wealth funds and pension funds have a return threshold, and it is beneficial to them if they can meet it by taking the lowest possible risk – which is debt. Returns are close to equity, and debt benefits from additional structural protections.”
For CIM’s Lev-Ari, current market conditions spell opportunities for lenders with dry powder to invest. “Markets where there is a very strong banking system, such as the Nordics or Germany, are generating more opportunities because banks’ appetite is lower when they consider the risk weighted assets on their balance sheets.”