Despite recent alarm bells in the global stock markets, triggered by fears of a spike in inflation and interest rates, competition to provide real estate debt in the continental European market has remained extremely strong during the first quarter of 2018.
The market is characterised by an increased number of private debt vehicles aiming to take market share from the traditional banking sources of property debt. This is set against a backdrop of strong investor demand, both for equity and debt. We are seeing synchronised economic growth across Europe and, despite ongoing political uncertainty, the commercial real estate debt markets remain liquid.
There are two major drivers of this supply. Firstly, the sources of capital have become more disparate. Capital comes not only from traditional lenders but from an increasingly greater number of debt funds, institutional investors and other equity and debt capital markets investors. Some of these are pushing their risk boundaries up a notch and some are pushing them down, all converging their interest towards real estate debt.
Those pushing their boundaries up – moving from traditional fixed income into real estate debt – are accepting illiquidity risks in exchange for better returns: the long-lasting, low-interest-rate environment continues to push institutional and debt capital market investors towards more lucrative forms of investment, such as property debt.
Those pushing their risk boundaries down are responding to the relative shortage of physical asset stock across Europe in a more crowded market than we have seen before, as well as concerns that we are reaching the end of the cycle and the volatility risks of global stock markets. They are therefore beginning to provide debt due to its defensive qualities.
Secondly, there are more financeable geographies and sectors across Europe. There has been a widening and deepening of what is considered the mainstream real estate market.
Investors’ interests are now spread across more jurisdictions than ever before, and cover additional asset classes, including operating assets such as hotels, student accommodation, healthcare, data centres, industrial assets and senior living.
Development finance, which until recently was predominantly confined to the UK, has begun to reappear across Europe, with even speculative development finding favour with debt investors seeking higher returns.
Importantly, this strong increase in the supply of debt and the broadening of investment scope has not given way to the re-emergence of some of the riskier practices that existed in the lead up to the global financial crisis, where we saw artificially high pricing for real estate assets coupled with a loosening of controls available to debt investors.
As we head further into 2018, there is a battle looming between the public and private debt spheres. The incentive for banks to deleverage further ahead of the introduction of Basel IV regulations may encourage debt funds to begin providing more liquid forms of debt instruments to serve capital markets investor demand.
However, the public debt space may prove a force to be reckoned with; we detect a revival in interest in liquid and tradable mortgage-backed securities that has gathered momentum in recent months. With debt being provided to the property market through a variety of avenues, competition will not let up this year.
Marco Rampin is head of Continental European debt and structured finance at CBRE.