Q&A: Cyril de Romance, Partner, First Growth Real Estate

Investors are exploring continental Europe’s accommodation sectors, including apartments, hotels and student housing. Cyril de Romance of real estate credit advisory firm First Growth Real Estate explains how debt providers are following

This article is sponsored by First Growth Real Estate.

What is driving investor and developer interest in continental European accommodation?

There is a general undersupply of accommodation property across continental Europe. Crucially, there is a mismatch between the existing ‘beds’ stock and the changing needs and expectations of end users. For instance, there is a need for higher-quality apartment buildings in many cities. University towns across the continent are attracting more foreign students who want modern accommodation. There is also a need for more senior-living facilities due to the ageing European population. Factors like strict planning regulations and a lack of land are putting severe constraints on the supply of new accommodation stock where it is needed.

However, the level of supply of such stock is gradually rising as these sectors attract investors and developers. They see the beds sectors as defensive investments because they are underpinned by demographic factors rather than cyclical demand. They produce stable cashflows and provide long-term growth prospects. Investments in such sectors also help to create diverse real estate portfolios. Institutional investors are growing their exposure to residential real estate.

How are lenders responding to investors’ interest in the beds sectors?

There is a growing appetite from lenders to provide finance against this type of property. Lenders are adjusting their product offering to capitalise on high investment volumes in multifamily apartments, both for sale and to rent. The market is less dominated by specialised residential investors and lenders.

However, the shorter average loan duration, for example in residential development, is a barrier to entry for some, and especially for banks. We see banks and funds entering the €20 million-plus part of the market, but smaller transactions tend to be financed by specialist lenders.

We are currently sourcing finance for a borrower’s mid-size Spanish build-to-rent portfolio, and we have secured attractive terms from an alternative lender who liked the risk-adjusted return such an opportunity provided.

“Operational real estate is among the most exciting asset classes in Europe”

How do lenders view the European hospitality sector?

There is strong lender demand for hotel deals, with growth in hotel values driving investment volumes. Margins have compressed in the city centre hotel market, meaning some lenders are interested in financing seasonal leisure assets, such as ski or beach resorts.

We recently structured debt for two hotels near Disneyland Paris and we received strong lender interest, even though they were held under leaseholds, which is unusual for France. Hotel development lending is difficult for some lenders because of the high development costs compared with the initial completed hotel value.

Senior debt loan-to-value levels increased across the market recently, but they remain lower than in the office market. Some banks have a low maximum allocation to hotels, which means there is a greater market share for alternative lenders. We expect to see the emergence of specialist hospitality lending funds.

Are lenders expanding into specialist residential sectors with flexible lease structures, such as co-living, serviced apartments and student housing?

Yes, but to a lesser extent than mainstream residential or hotels. Lenders are increasingly familiar with such assets, but they lag investors. There has been strong growth in the European student housing sector and there is room for more growth, particularly in France and Spain where supply is gradually catching up with the UK and Germany.

We structured a senior/mezzanine loan in 2018 for the Kley student housing portfolio in France and there was strong interest from local and international lenders, even though most of the portfolio was under development. Co-living remains embryonic and we have not seen many lenders expand into the asset class.

How do lenders get to grips with financing properties leased to operators?

They need the ability to underwrite operational business plans and take a view on the capabilities of start-up operators in nascent asset classes.

We are helping a newly launched owner-operator source finance for a French serviced office and co-working portfolio on an asset-by-asset basis. Local lenders are willing to provide competitive terms.

For some lenders, expanding into residential lending often means teaming up with a specialist residential lending platform to access a deal pipeline.

However, in continental Europe specialist lending platforms are less developed, which means developers tend to borrow from local banks.

Are lenders following investors into southern European residential markets?

The lack of opportunities in the UK due to the Brexit slowdown is encouraging them to look for deals in places like Italy, Spain and Portugal.

Lending in smaller, less liquid markets enables them to achieve higher yields. But they need to educate themselves as they move into such markets, which can be very different from the UK.

How do lending terms differ between European markets?

Senior loan margins in France are tighter than in the UK, but the opposite applies for subordinated loan margins. Margins are significantly higher in southern European markets because they are less developed and less liquid, but the spread compared with more mature markets is gradually compressing.

Do international lenders compete with local lenders in European residential sectors?

International debt funds typically offer higher loan-to-value ratios and can execute deals quicker than local banks, which allows investors to secure transactions more easily. However, there is the potential for European banks to cooperate with debt fund lenders – such as by providing loan-on-loan finance, or by providing the senior component of a whole loan, while the debt fund writes the mezzanine. Deals that involve complexity, such as numerous drawdowns or tenant eviction risk, are often declined by banks, which see them as too time-consuming or complicated to underwrite.

How can debt advisors play a role in the growth of operational real estate sectors?

Being based in continental Europe is essential. Advisors can increase clients’ certainty of execution by pointing them towards the most appropriate lender. It can be helpful to source asset-by-asset finance with local banks and then refinance with an international lender at the portfolio level. It is also about helping borrowers devise their business plan and projected cashflows, advising on suitable ownership structures to enable them to attract the appropriate finance, and bringing down loan pricing by creating competitive pressure. It is important to help investors educate lenders about emerging asset classes or country markets they may not be familiar with. Previous experience as an investor helps to create an understanding of concepts such as value-creation drivers, breakeven occupancy costs and regulation. Sourcing finance can require creativity and negotiation when assembling senior and subordinated loan structures, for example.

What other continental real estate sectors are interesting?

We see a lot of business in the office sector, including both traditional and serviced-office space. There is a lot of interest in logistics and warehousing. Retail is generating a lot of business as well. We are doing a lot of work for clients in restructuring, such as renegotiating loans with lenders, but also debt raising and special servicing. However, operational real estate is among the most exciting asset classes in Europe and rewards those with experience of financing it.