The real estate debt markets are flush with liquidity and it would be timely for sponsors to evaluate their borrowings and get ahead of their requirements, argues Riaz Azadi, managing director at Eastdil Secured
Debt typically represents as much as 65 percent of a firm’s total gross assets under management, meaning that leverage plays an important role in supporting property firms’ business plans. It is also critical in enhancing returns that sponsors deliver to their investors.
The evolution of the European debt markets from mostly bank-led to multifarious sources of liquidity has broadened the scope of borrowers’ options.
Having a trusted debt advisor to consider borrowers’ numerous considerations and navigate the debt capital markets ensures market transparency, efficient processes, crisp deal information and term certainty for borrowers and lenders alike.
While borrower considerations will vary across the returns spectrum and each individual debt deal can be nuanced, sponsors should take the following points into consideration. Some may appear obvious considerations, although they are often not adequately addressed.
- Lowering the all-in rate
Loan spreads from lenders on core assets continue to be competitive and are today comparable with spreads in 2006-07. This reflects several factors post-crisis, including but not limited to:
- Bank loan-to-deposit ratios indicating significant lending capacity;
- An increased number of international lenders active in Europe;
- Increased cross-border activity amongst European lenders;
- Increased lender diversification to include banks, insurance companies and senior debt funds;
- Demand from debt fund investors for more product;
- Balance sheet management and deliberate growth by lenders of assets under
Pricing at the core end of the market provides an indication of the pricing compression seen across the board where senior lenders are active. Suffice to say that the lending market for core assets is in a strong place from a borrower perspective, boding well for sponsors seeking leverage for core-plus strategies and value-add assets in gateway cities, as well as operating assets.
In addition, LIBOR and EURIBOR swap rates remain at all-time lows, providing borrowers with the opportunity to lock-in record low all-in rates. It is also important to note that where bank lenders are more restricted on leverage, there is typically a diverse and active source of non-bank lenders with greater flexibility.
- Business plan flexibility
Equal in importance to the cost of borrowing, maintaining sufficient flexibility in loan facilities to allow for asset management to drive value is critical for all sponsors.
Having a robust lending market supports customising loan structures in order to support both sponsors and their business plans. It is an area in which lenders – banks, insurers and alternative lenders alike – are trying to differentiate themselves from the field.
Navigating loan structures which meet borrowers’ individual needs in an increasingly competitive investment market, balanced against continued strict lender underwriting discipline remains a critical aspect of crafting appropriate financing structures.
Refreshing loan structures to reflect updated business plans and to benefit from new structures available lays important groundwork for the next stage of a sponsor’s value delivery. Make sure you have that flexibility.
- Risk and return management
As is the case with lenders, borrowers must constantly assess risk factors across their holdings, within the context of how advanced the delivery of their business plan is relative to their investment horizon.
Such factors include:
- Staggering loan maturities;
- Broadening the stable of lenders to diversify exposure across lender types;
- FX management depending on origin of equity;
- Maintaining/enhancing dividend yield;
- Pooling assets for aggregation.
At the same time, borrowers must take note of potential changes in the regulatory environment for lenders, as well as the impact of domestic politics on lenders’ businesses, changes in QE, performance trends in global public equity and bond markets, and economic indicators such as inflation and interest rate pressures.
All of the above can provide an impetus for quick step-changes in the commercial real estate debt markets which is all the more pertinent given the current low market volatility.
This means that as sponsors compete to deliver investor returns, mandating a debt advisor to parse through a diverse and increasingly complex financing market is critical in delivering market-leading terms for investors, unlocking and supporting value delivery and protecting investments from exogenous events.
Given the volume of debt capital available in the European markets today, borrowers should consider getting ahead of their borrower needs, while the choice is still there