In 2008 the European property markets were entering a historic correction in the face of the unfolding global financial crisis. The commercial real estate (CRE) debt market preceding this turning point was extremely liquid and deep. Dominated by banks, cheap leverage helped propel capital values to new highs. The corresponding pull-back in liquidity, prompted by changing capital rules in the form of Basel II, was compounded by the financial crisis and corresponding recession.
The recovery was slow but ultimately steady, and new alternative lenders – including insurance companies and debt funds – started entering the market and now account for roughly 25 per cent of lending in the UK.
The CRE market is once more faced with challenges driven by a new phenomenon that has impacted markets globally: COVID-19. While the underlying root cause is vastly different, some of the uncertainties the market faces today are like those witnessed in 2008:
- The shape of the economic recovery was unclear.
- Rents were expected to decline in most asset classes.
- Additional risk premium was required, and yields moved outwards but not uniformly.
- The market was illiquid, characterised by pricing differentials between buyers and sellers.
- There was very little availability of debt.
But there are some distinct differences that will positively impact availability of debt during this cycle:
- The banks are much better capitalised.
- Loan-to-value ratios are substantially lower.
- There is a more diverse CRE lending market, and alternative lenders are well established.
- Governments have acted with extraordinary speed to provide liquidity to the market.
With interest rates low and yields ever compressing, investors are increasingly viewing real estate debt as a means to enhance returns.
Transaction volumes have been lower since Covid-19 and leverage has also reduced. Debt origination by the banks is once again focusing on larger investments with LTVs of 45 per cent - 55 per cent, non-bank lenders are increasing their market share as older loans mature and roll off the banks’ balance sheets. This is due to banks focusing on reducing their regulatory capital requirements by allowing loans to refinance away from their balance sheets to ensure there is less potential for defaulted loans.
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 healthcare are the most liquid asset classes and continue to ensure there is good diversification in pan-European CRE debt portfolios, replacing weaker asset classes. We are now seeing more emerging sectors such as Data Centres, Self-storage, and Life Sciences.
There is no single pan-European approach to lending. 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 are interesting equity opportunities for investors, debt investing continues to provide an attractive, robust income-based return underpinned by property.
Non-bank lending is now well established across Europe and the market continues to grow and continues to provide attractive risk-adjusted returns.