SPR Seminar: Cost of Capital
Thursday 11 May, AEW Europe, London SW1

Extend but not pretend?

In this seminar on finance costs and lending conditions across the UK real estate markets, David Dahan of CREFC Europe set the scene with a review of trends in market sentiment among the lending community.  He noted that overall sentiment has improved significantly since a low point in Q4 2022, which was heavily influenced by the Truss-Kwarteng experiment, with sentiment also improving for debt availability and new business volumes.  However, sentiment regarding debt pricing and lending terms has proved stickier and remains negative overall.  Offices and retail are the sectors where sentiment is weakest.

Negative sentiment is reflected in the funding gap for real estate across the UK, France and Germany, which has now increased to an estimated €51 billion, according to Hans Vrensen of AEW Europe.  This measure of the difference between the lending available from banks, institutional lenders and other debt market players at current rates and LTVs compared to the volume of loans needing to be financed or refinanced has been mainly driven by the fall in asset prices through 2022. The problem has been exacerbated by a reduction in the loan-to-value (LTV) ratio at which lenders are willing to finance real estate from around 60% to 50%, given the perceived increase in risk. He suggested that over time the funding gap would be bridged by a combination of equity top-ups, junior debt, loan extensions and restructurings, although there would also need to be some loan write-downs and discounted loan sales.

Lushan Sun of LGIM Real Assets agreed that market participants were starting to adjust to these challenges, with lenders willing to extend loans and accept lower LTVs for limited periods.  This inclination to ‘kick the can down the road’ was based on the assumption that more normal market conditions would return reasonably quickly.  She proposed that this could prove to be a favourable time for non-bank lenders such as Legal & General to enter the market, as banks’ activities were likely to be severely curtailed.  But for her organisation, new lending would be selective on sectors and restricted to high quality, prime assets.  Refinancing weaker properties, particularly offices and retail, could be a much bigger problem.

As Vrensen had previously explained, funding costs for UK commercial real estate mortgages are now hovering around 6%, based on lending margins and swap rates, although they are somewhat lower in the EU.  In his presentation, Peter Papadakos of Green Street suggested that the long-term effects of higher interest rates and borrowing costs were looking ‘fairly discouraging’ so far.  Peter predicts that European pricing is likely to head a little lower over the next 12 months to hit a peak-to-trough decline in private property pricing of 30%. 

In the panel discussion led by Camila Moreno of Chatham Financial, there was agreement that the cost of debt across Europe has yet to peak, with this likely to happen in the next 12-24 months.  Responding to a question from the audience, Vrensen suggested that the limited availability of debt for development finance was not a bad thing, although Dahan proposed there were still some legitimate demands for development funding in the residential sector. For existing secondary assets, Vrensen thought the need for heavy capex to meet sustainability requirements might have been overstated, though he did admit that portfolios of non-performing loans on such assets could appear on the market in a few years’ time.  Even more negatively, Dahan wondered whether equity investors had already taken their returns from this kind of assets and were willing to write them off completely.

Tim Horsey