MAGAZINE: No sign yet of end to uncertainty in debt markets

The public markets are closed, offices are tough to finance, while problems loom for refinancing assets bought at 2021 values. Jane Roberts reports on Europe's real estate debt markets. 

For a financing proposal that involves the words ‘secondary office’, any meeting with an investment committee is likely to be a very short conversation, says Chris Gow, CBRE’s head of debt and structured finance for UK & Ireland.

Commenting on current debt liquidity for real estate, Gow is at pains to stress that distress in the European office sector due to changes in working practices is not as deep as it is in the US, where his colleagues confirm that American banks have slammed their doors on any more office lending.

Gow cites an April $500 mln refinancing which CBRE advised on, of 919 Third Ave, an 80%-let Manhattan office tower owned by SL Green. Gow observes it’s noteworthy that there were no US banks in the five-strong club which wrote the loan against the 140,000 m2 skyscraper at a 250 basis points margin, with the cost swapped to a fixed rate of 6.11%. The lenders were: Aareal of Germany, Crédit Agricole of France, Bank ABC of the Middle East, plus non-bank US lenders MetLife and PacLife.

In Europe, there is liquidity, even competition to lend on some offices, said Nick Harris, Savills head of UK and cross border valuation, speaking at the adviser’s annual Financing Property presentation, launched on 24 May in London. But, only if your office is new, green, well-let and ticks 100% of the boxes. The evidence is that most of the tripling of the all-in cost of debt for prime offices is due to interest rates – margins have not actually moved out very much. However, at around 6%, borrowers face an all-in cost that is now higher than prime yields of 4.75% for City offices and 4% for the West End (see chart ‘UK Real Estate Cost of Debt’).

In the non-prime bucket, distressed sales of European offices are already with us, with banks initiating either consensual or non-consensual sales where breaches can’t be cured. At Canary Wharf, for example, two office buildings are for sale, 5 Churchill Place and 20 Canada Square, where borrower Cheung Kai Group failed to repay loans from Lloyds Bank which are both under water.

Refinancing wall
Harris and Gow say distress has been limited thus far, but both anticipate more to come, and not just in the office sector. There is a refinancing wall looming in the UK in 2024, when approximately £38 bn of debt is due to be repaid, according to the most recent Bayes UK Commercial Real Estate Lending Year-end 2022 report from City University, which was published in May. The first problems may surface in the three-to-five year loans written in 2021, because many are likely to be in trouble with LTVs deeply under water and interest coverage ratios in breach.

Gow points out that an investor who bought in 2018 probably saw both value appreciation pre-Covid and rental growth as well, helping to offset the fastest value falls on record in the UK (see chart ‘Market Reaction: Capital Value Correction’). ‘But a 2021 acquisition may have had no initial value appreciation and no rental growth. So, even if there is no problem with the cashflow, that asset is going to be revalued and at less than its purchase value.

‘We are going to see this come into focus in the second half of 2023: what happens to those loans if they go into cash-trap, or breach LTVs, causing problems for banks from a capital perspective?’.

Banks are supporting clients wherever they can, not least because most of their business is currently refinancing rather than writing loans for acquisitions. May’s Bayes UK survey recorded a record high proportion of refinancings, at 65% of the £48.6 bn of new lending last year. Gow says this chimes exactly with the split in CBRE’s debt advisory business, where 60%-65% of its work has been refinancing, about 25% development loan advisory and only a little working on acquisition loans.

At his presentation, Harris said loan volume remaining due this year is down significantly because many investors sought to refinance debt falling due in 2023, early. Bayes notes that borrowers that could, also extended loans out to 2024. 

Where borrowers can cure breaches, banks are often keen to ‘amend and extend’. On one refinancing of a maturing loan against a UK retail park, the two German bank lenders want to continue as senior lenders if the LTV can be paid down from 60% to 50%-55% and CBRE says the borrower client has ‘a multitude’ of mezzanine options to choose from to plug the gap.

Non-bank lenders
However, UK banks in particular can be restricted by capital risk weighting requirements; Bayes found around half the refinancings in 2022 involved a change of lender, which is well above the norm. European banks generally are not taking on large bilateral loans, anything over €100 mln, and the market is back to the days of clubs.

Harris and Gow point out that this is an opportunity, especially for non-bank lenders, whose market share in the UK has crept up to 31% of all origination and a startling 61% of development finance, according to Bayes. Gow is working on a residential deal with an insurance company lender comfortable to write a bilateral ticket for a residential refinancing at 55% LTV and a cheaper rate with a volume that could eventually be expanded to £250 mln. M&G Investments has written some big bilateral loans, such as the £200 mln refinancing of the maturing loan in CMBS bond ‘Ribbon’ in January for Vivion, secured on a hotel portfolio. With bond markets closed, there are more refinancing opportunities for the private market.

So, many lenders are busy, and there is liquidity for most sectors, especially beds, sheds and meds. ‘There is most liquidity for residential for rent and logistics, and sentiment is recovering for hotels and retail, particularly retail parks. US banks are getting behind science parks,’ Gow reports.

An obvious consequence of the volatility is that all transactions are taking longer. ‘It used to be three months, and now it’s more like 4-6 months because lenders are asking more questions and they have more internal barriers to jump,’ Gow says.

Hedging requirements have certainly changed from a year ago when lenders might only require 50% to be hedged, and now insist on 75% or even 100% cover. Market participants say this may explain why more debt funds have begun to offer fixed loans, Alliance Bernstein, Alpha Real Estate and Silbury being examples. The attraction to borrowers is their cost is certain and they avoid having to spend an additional £1 mln-£2 mln upfront on a cap.

Savills’ research for Financing Property included asking lender clients when price discovery would be complete and when European markets would return to more normal levels of investment deals. The answers were non-committal. Harris pointed out that more activity doesn’t necessarily mean values will stabilise. More evidence could instead mean valuations tumbling further.

Looking ahead to other trends that could cause volatility, Harris said the transition to green buildings increases the likelihood of stranded assets and consequently the emergence for the first time for this reason of stranded loans.

Right now, however, the biggest uncertainty remains where interest rates are heading and when they will peak, and that of course depends on the economy and on inflation in particular.

CBRE’s Gow remembers there was a time not so long ago when he rarely felt the need to look at the forward interest rate curve at all. ‘Now I check it every day and maybe several times. It is at the forefront of everyone’s minds.’


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