Welcome to the fourth instalment of the serialisation of our deep dive on the questions lenders need to ask during covid-19.
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 five crucial questions debt providers are asking themselves to ensure solid underwriting in the face of the pandemic crisis.
The deep-dive analysis on these questions is being serialised over the course of this week. Today, we are revealing the fourth question:
What do I believe the underlying real estate is worth?
In the current market, faith in the ‘V’ of the LTV is critical, but difficult to assess given a lack of transactions to benchmark pricing against and economic uncertainty. Lenders are spending more time interrogating valuations, including assumptions on an asset’s future use.
But, according to Ian Malden, head of valuations at property consultancy Savills, confidence in market valuations, at least in the UK, is coming back thanks to the return of liquidity, although just to some sectors. “Generally, there is more evidence in the market now for valuers to make informed judgments.”
One difficulty is in visiting sites due to covid-19 restrictions, and much depends on how long these will last.
Malden adds that while covid-19 will reduce LTVs from 60-65 percent to 50-55 percent in senior financing deals, stronger cashflows will warrant higher LTVs and more competitive pricing.
In lieu of transactional evidence of property values, some lenders are looking for comparable metrics. “We are more actively looking at the public markets and the REITs to get a sense of real estate value. We’ve been using all sources of information, as well as our instinct, to assess value,” says Jim Blakemore, global head of credit investing at manager BentallGreenOak.
“The LTV covenant is a great thing about being a lender in Europe,” adds Blakemore, “it is a pretty powerful covenant. But if values move by 3 percent, or even 10 percent, no one wants to see a deal default. The idea of enforcing and selling into a covid market is not good.”
Andrew Petersen, finance partner at law firm Alston & Bird, admits he does not get why lenders are currently placing any importance on valuations. “[They] are based on an assumption of the consequences of covid-19 which, in my view, questions their accuracy and reliability.”
Assem El Alami, head of real estate finance at German bank Berlin Hyp, agrees it is extremely difficult to come to a precise idea of what the market value of a property is today. Therefore, the bank has focused, even before the pandemic outbreak, on cashflow, which he says is a more stable indicator: “The values can at times be relatively volatile, whereas cashflows are our reality.”
He adds: “I think cashflows are an even more important factor than values. Rather than discussing whether 50 or 60 percent LTV is the right level, we prefer to engage in discussions on whether the debt yield should be, for instance, at 6 or 8 percent.”
Given the difficulties around market valuations, lenders are entering deals at reduced LTVs, aiming to protect themselves if the ‘V’ falls.