The true impact of covid-19 on debt markets will become clearer in 2021

We predict debt capital to shift towards alternative sectors, lenders to tackle distressed situations and banks to make strategic divestments.

The surge in covid-19 cases across Europe and tighter controls imposed by countries to battle the virus has made the prospect of an early 2021 commercial property rebound more difficult to believe.

For real estate lenders, hopes of a revival in dealflow and clearer underwriting conditions are pinned on a successful rollout of vaccines across the continent. So far, progress in countries, including Germany, has been slower than many had hoped.

This year may yet deliver a vaccine-enabled return to something resembling normal life. But if 2020 was the year the industry absorbed the initial shock of the pandemic, 2021 will be the one in which the longer-term consequences begin to be apparent. For a start, the scale of the economic impact of covid is yet to be realised. In November, the European Commission forecast euro area unemployment of 9.4 percent for 2021, up from 7.5 percent in 2019. If there is a real estate recovery this year, it could be set against a dismal economic outlook.

Meanwhile, we are likely to see evidence of structural shifts in Europe’s real estate finance sector, either caused, or exacerbated, by the covid crisis. Here are some of our predictions for the year.

Debt will follow equity into alternative property sectors:

Property owners will realign their portfolios from sectors undermined by the pandemic, such as retail and offices, towards those with more compelling stories – such as residential, particularly build-to-rent. Capital will also head towards niche sectors that have become more relevant in the past year – life sciences, healthcare, data centres and the like. In recent years, lenders have been moving into alternative sectors. They will spend much of their time in them during 2021.

More debt strategies will be launched. But few will take undue risks:

The further retrenchment of banks from the sector in 2020 meant alternative lenders gained access to relatively low risk deals at higher pricing. Investors and managers will be attracted to European real estate debt in 2021, including new entrants to the market. But although there will be lots of non-bank capital available – ranging from senior, to mezzanine, to special situations debt – most parties will take a cautious approach. They will look for deals involving quality properties in tried and tested locations.

There will be strategic loan sales:

Banks will offload new non-performing loans this year. Some will also strategically divest sub-performing or even performing loan books. The covid crisis will accelerate banks’ realignment of their real estate portfolios, and some will be keen to remove higher-risk loans such as development facilities from their books to reduce their regulatory capital burden. That creates a huge opportunity for alternative lenders keen to scale their businesses by purchasing existing loans.

Time will be called on forbearance. But there will not be a bloodbath:

As the impact of covid on property values becomes clearer, lenders will aim to resolve distressed situations. That means covenant waivers and other forms of forbearance will be discontinued in the coming months. But the spirit of collaboration witnessed in 2020 is likely to continue, with lenders and borrowers working together to cure covenant breaches. Enforcement will be most prevalent in the retail space, though it is an inevitability for many assets that were already in trouble before the pandemic. Across the market, it may be debt fund managers that need to get tough – they have fund lives to honour and returns to make.

There will be more pressure to be sustainable:

Environmental, social and governance factors will be crucial to property owners’ decisions about how to redesign their portfolios for a post-pandemic world. They will demand that lenders support them by providing finance aligned to ESG objectives. In 2020, several lenders demonstrated that they kept their eyes on ESG. In 2021, pressure on those without defined sustainable lending products will grow.