SPR Webinar: Debt Financing
Wednesday 6 March 2024

Cleo Folkes of Property Overview moderated the first SPR webinar of 2024, which looked at current conditions for real estate debt financing from the viewpoint of both borrowers and lenders.  She introduced the session by reflecting on recent changes to debt market conditions following the sea change in interest rates and subsequent downward pressure on real estate values.

Setting the scene in more detail, Mohamed Ali, Debt Research Analyst at Savills IM stressed that private market debt had grown rapidly between 2008 and 2022, a period when the returns on private equity and private debt exceeded those in public markets, in part because of the associated illiquidity premium. These trends were shared by real estate debt, with many borrowers looking to boost returns in a low interest rate environment, while lenders have also enjoyed considerable protection against downside risk.  Non-bank lenders took a greater share of the European market, though this is still well behind the American level.

However, with the onset of much higher interest rates, focus has turned to the huge amount of debt – some €550bn across Europe – coming to maturity and requiring refinance.  The ‘funding gap’ resulting from declining values and bank retrenchment is posing a big challenge for borrowers.  From the lender’s perspective, returns over 2020-23 have been relatively healthy at around 5% pa – based on the limited available data – while the underlying real estate returns averaged a little above zero.  The risk for debt investors from default has been relatively limited given the strength of occupational markets while most began the downturn with a strong equity cushion that hasn’t yet been completely eroded.  And as and when values start to revive, this downside protection should expand once again.

Gwendal Kalkofen of Europa Capital Partners was the first to speak on the panel at the webinar, each of whom considered how the debt market is now functioning from their own perspective.   He noted that although market conditions are not yet getting any easier, for investors in core real estate with low gearing there is still plenty of liquidity available; it is further up the risk spectrum that things get more difficult.  Although banks are clearly constrained by the requirements of Basel regulations, this does not necessarily mean that alternative lenders represent ‘the holy grail’ for all lending needs. Borrowers therefore need to maintain strong working relationships with their lenders to pre-empt problems.

One advantage of using alternative lenders can be the chance to obtain higher LTV’s than from the banks, stressed Thibaut Laffaire of Tristan Capital Partners, since the latter have reduced their maximum LTV ratios in light of the perceived riskier market conditions.  Certain types of product, such as shopping centres, have been particularly hard hit due to structural changes in the market, which have also impacted the cost and term of the finance that banks are prepared to offer.

Martin Simonneau of Tishman Speyer noted that financing difficulties now sometimes also extend to offices, which were once ‘the darling of investors’, in part because of the growing complexity of management, with tenants often demanding a higher level of service in the age of working from home.  In 2023 it was also virtually impossible to raise finance for speculative development, with lenders increasingly questioning such assets’ prospects.

There is however a good chance that financing conditions will ease considerably once central banks have clearly embarked on the path towards lower interest rates.  The timing of this turning point was getting ‘emotional for everyone’, he said in the audience Q&A that followed, as this would then entice core investors back into the market.

Answering a question on whether the regulatory arbitrage that currently benefits alternative lenders over banks might now be curtailed, with regulators turning their focus to the risks facing them, Kalkofen agreed that this might well occur through a tightening of Solvency II in Europe in terms of how much insurance companies can lend and the kind of assets permitted.

The panel session ended with a discussion of the impact a building’s ESG credentials could have on the availability of finance.  Both Laffaire and Simonneau agreed that such qualities had effectively become essential in lenders’ eyes – where there once may have been a higher margin for failure to meet the standard, now the property would be ruled out from the start.

Tim Horsey