Loan-to-values plummet during first half of 2023

Leverage levels in acquisition, refinancing and construction loans have fallen sharply this year, according to data from digital property finance platform Finloop.

Average loan-to-value ratios provided to European real estate borrowers dropped by 11 percentage points during H1 2023, declining to an average of 50 percent LTV by the end of June.

The UK-based firm, which studied €5 billion of transaction activity during the first half of 2023, attributed the decline to rising interest rates in the UK and continental Europe. 

In August, the Bank of England made the 14th consecutive increase in interest rates, by 25 basis points to 5.25 percent, while the European Central Bank raised its key lending rate to 4.25 percent in July.

The decline across Finloop’s sample was steepest in the office sector. Average LTVs for offices decreased from 59 to 35 percent, the largest change across the sectors. 

But there were declines elsewhere, including a 22 percentage-point reduction for the retail sector – from 76 percent to 54 percent. There was a 19 percentage-point decrease for student housing and an 18 percentage-point drop for logistics assets – where average LTVs are now 47 percent. 

The hotel sector, however, registered a 7 percentage-point increase to 47 percent LTV – the only sector with an increase. Nicole Lux, co-founder and chief operating officer of Finloop, said low loan-to-cost ratios, which are now 49 percent on average, from 64 percent in 2022, across residential and commercial development, was indicative of a construction slow down. “These subdued loan-to-cost ratios suggest a cautious approach and reduced appetite for financing in this segment.” 

Lux added the adjustments in LTVs, together with further increasing property yields across European markets, have “improved loan affordability” because initial interest coverage ratios are higher, meaning a borrower is more able to service its debt. 

But she added some sponsors were being forced to sell assets in cases where property values have fallen too close to lenders’ loan amounts.  “Investors that require refinancing are faced with a gap due to the lower LTVs, lower property values and a huge refurbishment bill on top. This means they have to inject new equity, which they don’t have, triggering a sale. 

“This activity will keep increasing because funds don’t have the additional equity to keep assets that need substantial equity for refurbishments to improve their value. There have already been many sales executed at a loss, none of them was a free choice.” 

Lux added that as European real estate investment trusts were still trading at discounts of 30-40 percent during the first half of 2023, it was an indication that the market expects further declines in property values.

Loan margins over the three-month EURIBOR rate were lowest for residential loans with an LTV of 50-60 percent, at 1.90 percent. 

For development schemes in the residential sector, however, a loan-to-cost ratio of up to 60 percent, means the borrower would pay on average 4.5 percent over three-month EURIBOR and an average 5.8 percent for loans of more than 60 percent LTC.

For prime assets in the office, retail and logistics sectors, average margins were 2.50 percent for loans with an LTV of between 50 and 60 percent and for loans with an LTV of over 60, margins averaged out at 3.10 percent. 

For prime hotels, the margins are higher; 3.50 percent for a 50-60 percent LTV loan and 5.50 percent for finance over 60 percent. 

For secondary office, retail and logistics assets, margins are 2.90 percent for LTVs in the 50-60 percent range, increasing to an average of 4.70 percent for a 60 percent LTV.

The highest margins are for debt issued against secondary student housing – an average 5.6 percent at 50-60 percent LTV. 

Loans for secondary housing assets have the lowest margins among the non-prime category – of 2.6 percent at 50-60 percent LTV.

Finloop also reported that while investors are requesting mezzanine and junior financing, these are being offered at LTVs of between 51 and 58 percent. 

“Mezzanine loans are not used as a leverage instrument to boost equity returns, but rather as a more flexible solution compared with senior debt. [It could be used to] turnaround assets or to solve a special situation for a short period of time on assets which might not be delivering sustainable cashflows to attract a senior debt offer,” Lux added.