Real estate debt specialists at a November Commercial Real Estate Finance Council event in London said uncertainty as to where interest rates will land, and a lack of clarity around how far property values will fall, is causing a significant slowdown in financing activity. However, panelists at industry body CREFC Europe’s Autumn Conference argued lenders still have appetite for the sector and will resume business in earnest once they see more stable market conditions.
Andrew Radkiewicz, global head of private debt strategy and investor solutions at manager PGIM, said real estate finance markets have reacted quickly to the macroeconomic environment. “We’ve got interest rate rises that have changed underwriting for new loans and have changed stress tests on existing books. The key driver now is less loan-to-value and more debt service, and therefore we have clearly an almost entire slowdown or pause in new financing.”
“Ultimately, there is an assumption of 20 to 30 percent value reduction, which every bank lender is factoring in”
Nicola Free, managing director and head of CRE for EMEA at US bank Wells Fargo, said the biggest issue for her as a lender is underwriting against huge volatility. “You’ve got swings in interest rates, FX rates and cap rates, coupled with high inflation and the war in Ukraine, set against a changing regulatory landscape, changing occupier demand and ESG requirements – there are so many variables to consider when looking at a deal.”
The extent to which interest rates will rise remains a major source of uncertainty. However, delegates heard keynote speaker Liz Martins, UK economist at HSBC, explain the bank has revised down its forecast for the UK base rate in the current cycle, and now expects just two more increases before it settles at 3.75 percent in February.
As well as rates, all eyes are on property prices. “Ultimately, there is an assumption of 20 to 30 percent value reduction, which every bank lender is factoring in,” said Radkiewicz. “Looking through to debt service coverage ratios, we’ve got much lower proceeds coming through the system.”
Banks’ reduced capacity to refinance outstanding loans is a challenge facing the industry, panelists agreed. “I don’t think we’re underestimating the scale of the liquidity requirement in the market,” commented Radkiewicz. “It is already reflected in any new lending. Spreads have come out, even on high-quality senior debt, to more than 200 basis points over 4 percent five-year rates. So, investment grade loans are priced at 6 percent.”
“What we’re seeing right now is chaotic price discovery, a period of almost no transactions. It’s very challenging to get accurate information,” said Philip Moore, head of European real estate debt at US manager Ares Management.
However, Moore expects to see opportunities as banks assess their portfolios. “Next year, we expect high base rates, and difficulty in refinancing and extending loans, so we think we’ll see risk relief trades and loans being sold by banks. They won’t necessarily be sold at big discounts, but banks will be aiming to offload risk to be able to lend again. So, next year will be interesting, but tough.”