Debt availability across Europe, much like the underlying investment markets, is markedly a two-speed market and can very clearly be split along the lines of jurisdiction and asset quality.
For vanilla, prime assets in the UK, Germany and a few other northern European countries, debt is available for good-quality borrowers. Funding options for such ‘super-core’ assets now include wholesale and retail bonds, bank lenders, insurers, debt funds and even CMBS, and this has driven down margins to levels not seen for some time.
It’s a very different story for assets outside these criteria. Assets considered secondary or with a ‘story’ (such as developments), outside the main cities and, in particular, in southern Europe remain either debt starved or punitively priced.
This has been mirrored in investment markets by a feeding frenzy for ‘super-core’ property, while ‘secondary’ property remains largely neglected. In the UK, overseas money seeking a safe bet drove yields on central London trophy assets close to record lows, while the popularity of, and yields on, secondary or regional assets continue to drift.
This will have to change, for two main reasons. First lenders’ and investors’ behaviour risks creating a ‘mini-bubble’ and those buying or lending on what is seen as ‘super-core’ assets are further up the risk curve than they think. Investors and lenders are waking up to the fact that better risk-adjusted returns are available away from the herd in areas now considered non-core.
Second, if all the available cash investors and lenders are targeting at property is to reach the sector, then the asset types the market is willing to consider investing in and lending on must expand; the volume of investment market stock that meets today’s narrow ‘super-core’ definition is insufficient to mop this cash up. Relative risk, returns, opportunity and competition will require lenders and investors to look more broadly.
The cautious optimism of lenders at MIPIM last month reflected this. They have the balance-sheet capacity to lend, but are competing too hard on deals meeting their ‘sweet spot’ in terms of asset class, location, jurisdiction and borrower quality, while being quick to emphasise the advantages of a “quick no” when a deal is outside this space.
However, there appeared to be an increasing acknowledgment that lenders’ ability to execute such a narrow focus cannot last forever. A growing number are starting to discuss ‘stretching’ their lending criteria to find and fund ventures where there are greater opportunities for gains in pricing and relationships (assuming the two can co-exist!)
The apparent disconnect between where lenders and investors see opportunities opening up is interesting. For investors at MIPIM, Spain and Ireland were the hottest opportunistic European destinations. A willingness to ‘take the pain’ in both jurisdictions (largely via the creation of bad banks NAMA in Ireland and SAREB in Spain) seems to have created a platform for realistic negotiations and pricing for investors – what has been referred to as ‘transparent professionalism’.
For lenders, the same process seems to have crystallised losses; the wounds are still too fresh – and, in many cases, too large – to tempt them back into these markets. Instead, they tend to place jurisdictions where they have been able to ‘extend and pretend’, such as Italy, further up their ‘opportunity’ agenda, rather than facing up to a sharp correction, such as in Spain. Here, corporate memory is less burdened by actual losses, irrespective of future risks, when it comes to decisions on where to allocate lending and capital.
This disconnect should not last long, as the relationship between property market performance and available finance is symbiotic; a thriving debt market is necessary to attract a wide investor pool and a steady investment stream is necessary to establish or stabilise market norms against which robust debt underwriting can be based. So it will be interesting to see who admits to being wrong first in terms of identifying the right opportunities.
Colin Throssell is head of property treasury at Henderson