They said it

“I think the more challenging news on rates is the Fed is going to want to make sure this inflation really gets down”

Jon Gray, president and chief operating officer of Blackstone, speaking to Bloomberg Television, says he expects the US Federal Reserve to hold rates at an elevated level to enable the economy to “decelerate”. This, he adds, will contribute to credit becoming less available and more expensive.

What’s happening?

2022 surprises to the upside
Refinancing saved the day for lenders in the UK in 2022 amid a decline in property investment activity. The latest UK lending report by Bayes Business School [read analysis of it here] shows origination volumes, at £48.6 billion (€54.8 billion), were just 2 percent down on 2021 – which was considered a bumper year.

According to Nicole Lux, senior research fellow at Bayes, borrowers saw the need to get started on refinancing deals. “Borrowers took immediate action. They have not been waiting to refinance, because few expect interest rates to come down significantly in the coming 12-18 months.”

However, the report also showed lenders face increasing problems in their existing loan books as rising rates put pressure on interest coverage ratios. The average default rate across all lenders increased from 2.9 percent at the end of 2021 to 3.5 percent by the end of 2022. The UK real estate lending market remained somewhat liquid during H2 2022, but this finding demonstrates rising rates are nevertheless still taking their toll on debt providers.

More ways to lend
One lender with growth in mind is Waypark Capital, which has launched a fixed-rate loan product after raising £300 million from an institutional investor. The firm entered the market in July 2022 with £450 million of firepower from credit investment company Aeon Investments. The strategy will see the London-based company issue loans of between £10 million and £35 million, backed by residential, student accommodation, build-to-rent, logistics and industrial. The finance, which can be offered on 20-year terms, will be at loan-to-value ratios of up to 60 percent and issued at a minimum margin of 2.65 percent. Waypark’s chief executive officer Nicolas Vocos said the sharp rise in the cost of capital means borrowers were prioritising “certainty and visibility” in their funding costs.

Fundraising challenges
Non-bank lenders have been hailed by many as saviours within the property capital stack as bank lenders become more cautious. While they are playing a key role – as seen in the Bayes report – there is also evidence of debt fund managers facing challenges raising capital.

Last week, Real Estate Capital Europe reported Frankfurt-based manager KanAm Grund Group scrapped plans for its maiden credit property fund last year as geopolitical issues and rising interest rates deterred investors. The firm will reassess its position next year. In addition, Christophe Murciani, head of commercial real estate debt funds at Luxembourg-headquartered Sienna Investment Managers, which is aiming to raise capital for its Real Estate Debt VI Impact Fund, told us there is some reluctance among institutional investors for real estate credit strategies. Sienna had initially targeted €400 million for the fund, but now expects to raise in the region of €250 million-€300 million by final close.

“Most of our investors already have a big real estate exposure. Sometimes, they sit on the board of listed property companies, and everybody here in France was negative about the office sector and legacy assets, so that noise makes it difficult for them to commit to funds,” Murciani explained.

The reasons mount up
Real Estate Capital Europe reported last week that UK and South Africa-headquartered bank Investec has been appointed to advise on a majority sale of Mount Street, the London-based loan servicing firm. The decision to sell a stake in the business looks well-timed, positioned as it is at the junction of rapid growth of its loans under management and the expectation of more business to come.

The company grew assets under management by a record 72 percent during 2022 and onboarded 40 more staff. Further optimism for loan servicing business is in evidence in its latest annual accounts, published this month, in which it anticipated some of its current commercial real estate servicing book would move into higher margin special servicing business, adding: “Management also expects to win mandates for special servicing of loans that are currently now named with other servicers.”

Bad debt
In the US, there was further evidence of real estate distress. Two months after defaulting on $784 million of loans on Los Angeles offices, Brookfield Properties once again finds itself out of options to extend office financing. The real estate arm of Toronto-based manager Brookfield Asset Management last week defaulted on a $161.4 million commercial mortgage-backed securities loan for a portfolio of Class B office properties, as reported by affiliate title Real Estate Capital USA (registration required). The 2018 financing has already been extended three times, each for one year, prior to being transferred to special servicing. It was due to mature in August. The 12 properties backed by the loan are all offices, spanning Washington, DC, Maryland, Virginia, Florida and Georgia.

The loan joins a growing roster in special servicing. According to data firm Trepp, nine loans with a balance of at least $100 million were transferred in March. Trepp’s CMBS Special Servicing Rate rose 37 basis points in the month to 5.55 percent, its largest monthly increase since August 2020. For office specifically, which was responsible for around 35 percent of new transfers in the month, the rise was 34bps.

Trending

There may be (less) trouble ahead
Base case scenarios for the European real estate market used by manager AEW for its mid-year European outlook are an improvement from last September, when it foresaw stagflation dragging on growth. In a report published on 25 April, it now assumes recession is avoided in 2023 and a rebound in capital values and total returns in 2024 is in sight. “Our new base case scenario,” says AEW, “assumes that inflation normalises in 2023 with a slow and steady recovery.”

While uncertainty remains “high” it is projecting returns across all sectors of 6.8 percent per year between 2023 and 2027, up from the 4 percent it predicted six months ago. This has not, however, changed its assessment of the debt funding gap, which it still estimates to hit €51 billion between this year and 2025, 60 percent of the gap post-global financial crisis.

Oaktree’s observations
The commercial real estate market is still likely learning lessons from the failure of Silicon Valley Bank and Signature Bank and trouble at First Republic Bank. Oaktree Capital Management co-chair Howard Marks penned a memo on 17 April detailing how the failures may amplify existing wariness among investors and lenders. The result of such caution could lead to further credit tightening.

“No one knows whether banks will suffer losses on their commercial real estate loans, or what the magnitude will be,” Marks wrote. “But we’re very likely to see mortgage defaults in the headlines and, at a minimum, this may spook lenders, throw sand into the gears of the financing and refinancing processes, and further contribute to a sense of heightened risk.”

Some firms – including PIMCO and Brookfield Properties – have already started to encounter default situations in the office sector.

The heat is (back) on
Buyers surveying European real estate opportunities are tightening their focus on the UK market. After eight consecutive declines, MSCI’s UK Monthly Property Index turned positive in March, generating a return of 0.67 percent, of which the capital return component was 0.21 percent. This may indicate that values have reached a floor in Europe’s hardest-hit market, with the UK expected to lead the global recovery in deal activity. Indeed, affiliate title PERE’s latest analysis finds competition is already heating up. “It doesn’t feel like bargain pricing, and we’re having to compete against some of our peers and get somewhat aggressive to win these processes,” said Dan Valenzano, managing director of pan-European transactions at Patrizia. Despite the scale of the opportunity, there are nonetheless obstacles preventing a wave of new transactions. Access to financing, however, is not even the biggest problem buyers face. Read our analysis to see what is.

Data snapshot

Debt fund expectations
Despite the challenging fundraising environment discussed above, European real estate finance market participants see a growing role for debt funds. London-based finance industry body the Loan Market Association released the results of a sentiment survey ahead of its Real Estate Finance Conference in London last week. The consensus is debt funds have the greatest growth prospects.

Loan in focus

CaixaBank’s green BTR loan
Valencia-headquartered lender CaixaBank has provided its largest green loan of this year so far with a €197.5 million facility to property manager Greystar Real Estate Partners and Iberian developer Vía Célere for a build-to-rent portfolio in Spain. The seven-year financing, which is hedged against a potential rise in interest rates, will be used for the acquisition and management of a portfolio of 2,425 rental housing units in Spain. The portfolio comprises 22 buildings in areas of high rental demand, including Malaga, Seville, Valencia and Bilbao. In 2022, CaixaBank provided €8.14 billion in green financing, with €3.53 billion allocated to real estate projects.

Today’s Term Sheet was prepared by Daniel Cunningham, with Lucy Scott,  Mark Mwaungulu, Charlotte D’Souza and Randy Plavajka contributing.