Refinancing drives activity amid fewer acquisitions

Going into 2023, there were hopes among real estate finance professionals for more stability in the second half of the year if central bankers could tame inflation and ease off on monetary tightening. However, as Q4 approaches, macroeconomic uncertainty continues to set the tone in the industry.

Eurozone inflation was lower in July as growth accelerated, leading some to believe the end of interest rate rises is in sight. However, that month, the European Central Bank raised rates by 0.25 percent, bringing its key lending rate to 4.25 percent and prompting calls for a pause amid recession fears. In the UK, persistent inflation led the Bank of England to raise rates by 0.25 percent to 5.25 percent in August. In June, asset manager Schroders revised its UK rates forecast, predicting a 6.5 percent peak by the end of the year, followed by recession.

For real estate markets, continued uncertainty on rates is supressing investment as buyers contend with higher financing costs. Deal volume across Europe in H1 totalled around €65 billion, according to Savills, down almost 60 percent year-on-year. The consultancy forecasts €163 billion by year-end, which would be a 44 percent drop from 2022.

In the financing market, lending appetite varies by organisation.Some are focused on managing their existing loan books and dealing with problems caused by the rapid rise in rates. However, many lenders, particularly managers with dry powder, view a combination of higher loan pricing and less competition from banks as an opportunity to grow their portfolios.

With reduced acquisition activity, refinancing is keeping those lenders busy. Philip Moore, partner and head of European real estate debt at US manager Ares Real Estate, says demand for refinancing has been “continued and sustained”. In June, Ares completed its largest loan since establishing a European lending team in 2022, with a £300 million (€256 million) refinancing of luxury retail and a hotel in London, which Moore described as a good example of the financing opportunities the market is generating.

“In terms of the second half [of 2023], we are not yet seeing a material pickup in acquisitions in the market as the bid-ask spread between buyers and sellers persists,” says Moore. “Investors are still waiting for forced selling, which we are not seeing yet in any meaningful volume. That said, we do expect this to change. These shifts always take longer than expected, but we believe that going into 2024, there may be a handful of owners which have to make some tough decisions.”

David White, head of LaSalle Real Estate Debt Strategies, Europe, for US-headquartered LaSalle Investment Management, explains the firm’s typical target borrowers, including private equity sponsors, are in the market to address financing requirements of their investments. Around 80 percent of its pipeline is focused on refinancing solutions, which he says has led to a significant increase in dealflow volume for the business in 2023 to date, compared with the same period in 2022.

“A majority of the pipeline is in living sectors, logistics and life science sectors, but analysis of individual assets, and sponsors’ business plans remains critically important,” White says. “The sponsors we speak to during refinancing discussions are prepared to explain why they have conviction in their holdings and in many instances, we are seeing new equity capital being committed to support elongated business plans.

“So, conversations with sponsors are more collaborative than ever before, and focused on finding a structured credit solution in the face of forthcoming debt maturities.”

Pan-European picture

Across Europe’s real estate markets, debt experts report similar conditions. Speaking in private, one debt adviser in the German market says he does not expect investment to pick up significantly for the remainder of the year. “There may be more transactions in the latter part of the year,” the adviser says, “but they are unlikely to be large. There will be some sales in cases where borrowers need to refinance their assets, or where there are recapitalisation processes”.

Damien Giguet, founder of Paris-based advisory firm Shift Capital, says banks in France have been busy dealing with covenant waivers, loan extensions, and the beginning of some workouts. He has not seen significant distress but expects issues to emerge in Q4 2023 and Q1 2024 as banks become less likely to extend loans. “We see some situations of default, mainly in secondary offices, but there will be more to come,” he says.

Giguet also expects to see sales by French and German open-ended funds in response to investor redemptions. Opportunistic private equity funds will be the likely buyers, he says. However, he does not foresee a large volume of acquisitions this year. “Everyone is waiting for pricing to bottom out, for a stabilisation in values. Some believe this could require two years. Some expect more clarity in 2024.”

Adapting to conditions

Alberto López, chief executive of Madrid- and London-based lending platform AEXX, noted an increase in borrower enquiries in Spain beginning in the early part of summer. “Demand is driven by sponsors needing more capital. It clearly denotes a liquidity shortage – we are seeing more stress than distress with financing and capital structure issues that are putting enough nervousness in sponsors to seek alternative solutions.”

López adds property owners are waiting to see how conditions change, rather than opting for quick sales. “But I think there will be transactions in the market in the last part of the year, even if they are not distressed situations,” he says.

LaSalle’s White believes borrowers are adapting to “stabilisation in rates expectations” at new, higher levels. “The market has now had some time to digest what the math of higher interest rates means for real estate yields, against a backdrop of fairly resilient growth tracked by our economists. We are seeing a shift in borrower expectations to a more normalised interest rate environment in the future.”

While current conditions represent a growth opportunity to some, lenders insist a cautious approach to financing is crucial. “We are mindful of going into difficult sectors too early or in the wrong type of assets,” says Ares’ Moore. “It is tempting to jump in and lend when an asset’s value is down 20 percent, but we know that these can continue to fall materially and that it pays to be patient.”

“We often hear people say it’s the best time to be a lender, and there are equity-like returns for debt,” adds White, “but you need to peel the onion back further and understand individual asset-level fundamentals to ensure you’re taking appropriate credit risk.

“Overall, to unlock the right financing solution, you need to be collaborative with borrowers.”