As Europe’s economies emerge from covid-19 lockdowns, property debt providers are increasingly keen to get back to writing loans. But amid an uncertain marketplace, real estate lenders are reconsidering their underwriting assumptions.
Lenders know the economic fallout of the pandemic could undermine the performance of tenants and, subsequently, their customers, the borrowers. On top of that, the crisis is accelerating structural changes already underway in the industry.
Surging demand for online retailing has provoked a growing appetite for logistics; for the same reason, there is dropping demand for physical retail property. Also, with so many people working from home, the future use of office space is the subject of debate likely to continue for months, if not longer. All this is putting into sharp focus the need for debt providers to question their assumptions of, and appetite for, the sector.
As Ian Malden, head of valuations at property consultancy Savills, puts it: “These changes have an impact on the relationship that developers, occupiers, and borrowers have with their lenders and on how lenders react. Occupiers are seeking shorter and more flexible operational-style leases which will have implications on borrowers’ ability to optimise loan-to-values, leading lenders to be more risk-averse and, perhaps, more conservative.”
Debt providers’ appetite to finance new projects or sponsors varies depending on the type of organisation and its source of capital. Some debt funds, for instance, are busier than ever, picking up the slack left by senior lenders that have decreased leverage, according to a July market report by property consultancy Knight Frank.
Overall, lending principles have not substantially changed. But the due diligence process to underwrite a loan has become more forensic and exhaustive. A renewed spotlight has been put on sponsors’ cashflows and liquidity, as well as on core lending principles.
“Critically, covid-19 has forced a return to fundamentals: the quality of the asset, the sponsor and the cashflow, as well as assessing and understanding the structural changes happening in the market,” saidMalden.
From interviews with 16 market sources from the European real estate debt market, including bank lenders, debt fund managers, valuers, lawyers and borrowers, Real Estate Capital has identified the five key questions lenders are asking themselves to ensure solid underwriting in the face of covid-19.
The deep-dive analysis on these questions will be serialised over the coming five days, starting today:
Question 1: How well do I know my sponsor?
A focus on the sponsor is not new. Ever since the global financial crisis, when an increasingly structured finance market became dislocated from the users of debt, finance professionals have emphasised this point. But debt specialists argue it is more important than ever now for lenders to ensure they know their borrowers. Their financial strength, expertise and track record are paramount, they agree, to determine the chances of the sponsor successfully managing a property through potential additional waves of the pandemic.
Jeffrey Rubinoff, a real estate finance specialist at law firm White & Case, says: “Lenders are evaluating whether they have the sort of sponsor that will support the asset. Most real estate debt deals are limited recourse, so are ultimately dependent on the value of the asset. But people are now more concerned about who the sponsor is, and we might see less portability in loan deals.”
In real estate finance, the importance of the sponsor is sometimes clouded by the quality of the real estate, says Mohith Sondhi, senior director of debt finance at UK-based challenger bank OakNorth. However, he said, both will be equally important in a post-covid world.
Particularly relevant is the way a sponsor has operated during the lockdown period. “For a new deal, it is key to learn how sponsors are dealing with their existing portfolio; what actions they have taken? How proactive or reactive they have been?” says Sondhi.
In addition to understanding a sponsor’s track record, lenders want to know how well capitalised they are, should additional equity need to be injected into a deal.
Mark Bladon, head of corporate real estate lending in the structured property finance business of UK-headquartered bank Investec, says this is particularly important when financing development. “It is quite conceivable you are going to have cost overruns in this environment, so we need to know whether they have the ability to follow their equity.”
Borrowers canvassed for this article agreed on the importance of having an ongoing and open dialogue with lenders. John Dunkerley, chief executive of London-based private rented sector residential developer Apache Capital Partners, says: “Having regular contact and providing all the latest up-to-date information has been crucial to keeping a good working relationship during an incredibly challenging time for everybody.”
Karim Habra, head of Europe and Asia-Pacific at Ivanhoé Cambridge, the real estate arm of Canadian pension investor Caisse de dépôt et placement du Québec, says financing for value-add and development projects, on which the company focuses, is currently scarcer: “Covid-19 has reduced the availability of debt and fewer lenders are willing to take development risk due to the current market conditions. However, whenever deals are cashflow-secured, there is debt available for them.”
But mitigating covid-19 risk does not necessarily mean lending only to existing sponsors. Most lenders speaking to Real Estate Capital say they are open to new borrowers, provided they fulfil certain requirements.
Dennis Watson, head of real estate at UK bank Barclays, says: “We will be open to new sponsors. But if we take them, we will need to be very clear on their character, ability and management: they need to have a very demonstrable and identifiable track record to the business and the management team.”
Phil Hooper, head of real estate finance at UK bank NatWest, agrees. “It is typically more straightforward to work with a customer you have lent to before, as you have a shared experience. However, what is important for us is that a sponsor has a demonstrable track record for the kind of project they are asking us to support,” he says.