European commercial real estate debt markets have had a difficult time over the last two years. The global disruption due to the Covid-19 pandemic caused business levels to plummet. Markets recovered strongly towards the end of 2021, approaching pre-Covid levels, but the rapid increase in interest rates and the conflict between Russia and Ukraine has plunged markets into turmoil once again.
Several central banks globally have already increased interest rates to combat inflation and further rises are expected in the coming quarters. Market uncertainty and volatility are likely to persist over the next 18 months.
Whilst this backdrop can create a challenging environment for property investors, we believe there are also opportunities to capture both higher margins and a strong risk-adjusted return for investors.
The standard response of traditional lenders during periods of uncertainty is to reduce lending volumes. This creates a gap in the market for alternative lenders, particularly within the Core Plus Senior and Whole Loan real estate debt space.
Even pre-Covid, focus on Return of Capital has meant a continuing trend for banks to deleverage across their loan books and narrow the space to which they will lend, such as limiting by sector (e.g. retail) or focus on their largest borrowing clients.
We expect to see a significant slow-down in transaction volume as it will take some time for buyer and seller expectations to re-adjust, and the outlook in particular on the path of interest rates becomes more clear.
Debt availability is currently also a significant constraint for investors/owners as Lenders retrench and we expect to see a significant refinance opportunity for alternative lenders with available capital over the next 12-18 months.
The property market faces some significant structural challenges – there are economic and behavioural forces affecting asset classes disproportionally. Non-food Retail, Hotel and Leisure have seen the greatest impact from Covid-19. Logistics, Residential and prime Offices are the most liquid asset classes and continue to be the focus of the bulk of investment activity. The continued emergence of more alternative sectors such as Data Centres, Self-storage, and Life Sciences are replacing older asset classes such as Shopping Centres and contribute to building portfolios with good diversification.
There is no single pan-European approach to lending as each jurisdiction requires a considered approach to leverage, liquidity, local and international bank competition, maturity of local markets and sectors and legal protections such as enforcement regimes.
Whilst jurisdictions such as the UK, the Netherlands, Ireland and Germany have efficient markets where loan security can be easily enforced, further structural protections need to be considered for jurisdictions such as Spain, France and Italy. Experienced lending teams will have prior track records in these jurisdictions in order to build diversified portfolios with the best risk-adjusted returns.
In conclusion, while there will be interesting equity opportunities for investors, debt investing continues to provide an attractive, robust income-based return underpinned by property.
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