The story of 2020 – part 2: How debt providers got to grips with the pandemic-era market

In August, US lender Bank of America priced Taurus 2020-2 UK, a £450 million (€492 million) securitisation of part of a UK logistics loan provided to private equity firm Blackstone.

It was the first European commercial mortgage-backed securities issuance since March, and it demonstrated that there was investor demand for CMBS notes. It was also an example of a lender closing a big financing deal, despite the turmoil caused by the pandemic.

During the summer months, the supply of real estate finance remained constrained, compared with before the covid-19 crisis. Many lending organisations had spent their time since March addressing problems across their loan books and working with borrowers to avert or resolve situations of stress.

Bank lending remained focused on existing sponsors and core assets, with refinancing accounting for much activity. However, some debt providers, including alternative lenders, took the opportunity of a dislocated market to win new deals, typically at higher margins than before the covid-19 crisis.

In late August, we published a Deep Dive, looking at the questions debt providers were asking themselves before closing new lending deals. We found lenders were doing additional due diligence on their sponsors, closely examining cashflow from the underlying assets, considering protective mechanisms within deal structures and striving to work out what they believed the property was really worth. Crucially, lenders were asking themselves if they needed to write the loan or should step back from the market.

Throughout Q3, lenders closed some significant deals, including Germany’s Allianz Real Estate, which closed its largest single-loan debt deal in Europe to date with a £400 million London office portfolio financing in September.

Although lenders gradually increased their activity during H2, research published in October by investment manager AEW Europe suggested a refinancing gap was looming across European markets. The firm’s researchers said falling property values due to covid-19, combined with lenders providing less leverage, will result in some borrowers struggling to refinance their real estate loans in the coming years. The UK debt gap was expected to be around £30 billion, or 16.6 percent of outstanding loans. The German debt gap was expected to be €54 billion, or 10.5 percent of outstanding loans.

“The good news is, this time around, we expect much less of a refinancing issue than after the GFC, but it is still a significant problem,” Hans Vrensen, head of research and strategy at AEW, told Real Estate Capital at the time.

By Q3, debt specialists were speculating on when lenders would call a halt to forbearance with their borrowers, meaning distressed debt situations becoming apparent. In October, consultant Knight Frank’s head of debt advisory, Lisa Attenborough, said breaches of property loan terms by borrowers were likely to become more widespread in European markets by the end of the first quarter of 2021, following a prolonged period of forbearance.

“We started to hear of banks making large provisions for bad debts back in July, but many borrowers have been given six to 12 months covenant testing holidays, so the situation is still unfolding,” Attenborough said.

During the same month, the H1 2020 report issued by The Business School – previously Cass Business School – on the UK property lending market, provided hard data on covid-19’s impact on the sector. It showed new lending was down 34 percent year-on-year, to £15.5 billion during H1. It noted that the UK lending market experienced its second six-month period of falling origination and higher lending costs, and so had entered a “new downward cycle”.

Despite the slowdown in lending, real estate debt fund managers reported successful fundraising activity. In October, property manager LaSalle Investment Management announced the €435 million first close of the fourth vehicle in its flagship European mezzanine debt fund series.

Amy Klein Aznar, head of the firm’s debt and special situations business, told Real Estate Capital that some investors increased their commitments during the due diligence process. “We saw the same dynamics after the 2007-08 global financial crisis, with investors recognising that traditional lenders were pulling back, creating new lending opportunities. There is a feeling among investors that this will be a good vintage for real estate debt,” she said.

Other Q3 fundraises included Blackstone’s final close of its fourth global real estate debt fund on $8 billion in September. The firm said it was the biggest property credit fund ever raised.

The prospect of lending into a less liquid European real estate debt market also attracted new entrants to the market. In October, US investment manager Invesco Real Estate purchased the commercial real estate debt business of Swiss asset manager GAM, amid what it described as “very attractive” market conditions. In November, another large US manager, AllianceBernstein, entered the European real estate lending market by forming a partnership with Lacarne Capital, an independent lender formed in January. The platform launched with €1.2 billion of capital at its disposal.

In a statement, AllianceBernstein told Real Estate Capital: “Dislocation in the market today will create a particularly opportune environment for launching the new business.”

In November, news that an effective vaccine for the coronavirus was close gave real estate investors and lenders hope that the sectors worst-hit by the pandemic will begin to recover in 2021. However, lenders gave the news a cautious welcome.

Christian Janssen, head of the European property debt business at investment manager Nuveen Real Estate, commented: “Large parts of the market won’t return to their peak for a long time. I think people will go back to their offices and I doubt tenant requirements will shrink significantly. I also think parts of the retail market could have significant upside from their current position. However, I’m not so sure hotels will recover quickly. There is a danger a portion of the market does not come back to its former peak, maybe ever, such as business travel.”

As the end of 2020 drew near, real estate debt specialists were also left to ponder how much distress would emerge across the market in Q1 2021 as lenders brought forbearance to an end. In December, in our Deep Dive into how special servicers are dealing with troubled loans, one European servicer explained the options ahead for lenders in early 2021.

Bill Sexton, head of Trimont Real Estate Advisors’ European arm, said he expected lenders to seek consensual resolutions with borrowers on distressed loans, including injecting new equity or accelerating the repayment of loans. Enforcement action may be an inevitability for assets in the most troubled parts of the market, he added. “We will see some lenders take the keys back, and even some borrowers hand the keys back because they do not want to put more equity into a troubled property.”

While 2020 has been the most challenging year for Europe’s real estate debt industry since the global financial crisis of 2007 and 2008, the fallout from the covid-19 pandemic looks set to continue into 2021. However, with the beginning of the rollout of the covid-19 vaccine, many in the industry ended the year feeling hopeful that 2021 would bring better real estate financing conditions.