The limits of liquidity

Despite the amount of debt capital available, some borrowers struggle to source real estate loans in Europe.

From both an equity and a debt perspective, a lot of capital is focused on Europe’s commercial real estate markets. But according to panellists at last week’s Commercial Real Estate Finance Council (CREFC) Europe Spring Conference, there are limits to the debt market’s liquidity.

Using a golfing analogy, one panellist argued a large proportion of debt capital is focused “on the fairway”. In other words, if you are a borrower with a core asset producing a predictable income, expect to source affordable debt from a variety of competing lenders. If, however, you need finance for what was described as “edgier” property – be that a value-add project, a development or an asset located off the fairway – liquidity is less evident.

A combination of factors is at play. Post-crisis regulation has steered banks towards vanilla financing – appropriately so, given the events of the last cycle. As a result, an alternative lending market has sprung up to provide loans where banks are no longer willing, or able, to tread. However, non-banks remain a relatively small proportion of the overall picture.

Although insurance companies and pension funds are realising the merits of private debt, many remain unwilling to allocate funds to anything but senior lending strategies at this stage, limiting the firepower of managers eager to provide loans to transitional properties.

Another factor is the sheer challenge of aligning those aiming to lend to edgier schemes with the right sponsors and the right projects. Many non-bank lending organisations have small teams and financing transitional assets takes a lot of time and focus. Borrowers can struggle to find a lender willing to back their business plan which has the resources available immediately to undertake the necessary underwriting.

It cannot be a bad thing that lenders are not falling over themselves to provide loans outside core markets. However, there are experienced real estate investors and developers out there in need of funding to support schemes where there is genuine value to be added. It seems Europe’s real estate finance markets are not as efficient as some would like.

With no liquidity crunch in sight, lending markets will become more competitive and debt providers are likely to become more willing to back sponsors with track records as they aim to create additional value in transitional situations.

A note of caution is necessary here. While some speak about the difficulty of sourcing anything but vanilla finance, others provide anecdotal evidence that some lenders are chasing increasingly risky business. Indeed, one panellist at the CREFC event argued the increase in capital raised for private debt strategies is leading to some eyebrow-raising lending terms being offered in the market. Anecdotal evidence provided by the panellist included lenders willing to write speculative development loans in London or high-leverage loans for land acquisitions in Spain.

As the volume of capital raised for private debt strategies increases and as a greater number of lenders become active in Europe, it is inevitable that some will attempt to win business by taking more risk than is sensible. While too much lending capacity might be playing down the fairway now, as the market becomes increasingly liquid, more debt might be found in the rough.