European Debt Financing Review Q1 2023
April 24, 2023
Loan-to-value (LTV) ratios for new senior loans have declined in Q1 but the total cost of debt for prime real estate has stabilised and there remains liquidity for lending across all real estate sectors, especially for the Residential, Logistics and Life Sciences asset classes. These are the latest findings from the quarterly review of European real estate debt markets by the CBRE Debt & Structured Finance team, who advise lenders and borrowers throughout Europe on new loans and refinancing for real estate investment and development opportunities.
Average loan-to-value ratio for sample of European locations (%) – senior debt, prime assets
Source: CBRE Research
LTV ratios for new senior loans are notably lower than they were twelve months ago, which reflects the much changed conditions in both financial markets and real estate markets. A higher interest rate environment has brought the ability of rent to cover interest payments more into focus. While both interest rates and real estate yields have increased in recent months, the increases in interest rates have been quicker and steeper. Therefore, senior lenders have reduced the LTV ratios they are prepared to apply, to maintain interest cover on new loans at an acceptable level. This trend has been seen across most European markets and all real estate sectors.
For a number of borrowers looking to refinance, the combination of recent falls in asset values and reduced LTV ratios for new loans has created a funding gap. It has been difficult to replace the amount previously borrowed with like-for-like debt. Borrowers in this situation have been faced with injecting more equity or obtaining subordinate debt to cover any shortfall, but existing lenders have been working with borrowers to find solutions. Recently, we have seen good offers being made at loan maturity, as well as the use of trapped cash from the existing loan to reduce the LTV required at extension or provide interest reserves, which in turn can improve the terms on which a new loan is offered.
Total cost of debt has increased significantly
A notable trend has been the substantial rise in interest rates, and therefore debt costs, over the last twelve months. Central banks have increased policy rates to combat high levels of inflation and this has had consequences for both short-term and long-term interest rates. Yet while short-term interest rates have continued to rise, long-term rates moderated during Q1. As a result, our estimates of the total cost of debt for prime real estate (which use the five-year swap rate relevant to each country as a reference rate) were slightly lower for Q1 2023 than for Q4 2022. Despite this, the total cost of debt for senior lending has increased by 200-300 bps year-on-year.
We have also seen lenders reassess margins in the light of increased uncertainty in the economic outlook and changing market conditions. The average margin for senior loans on prime property assets has increased by 20-30 bpsin all sectors since last March, though with some variations across locations. However, relativities in margins between the main property types have remained stable. Prime multifamily residential assets are still seeing the lowest margins, while margins remain highest for the retail sector.
Average total cost of debt for sample of European locations (%) – senior debt, prime assets
Source: CBRE Research
Liquidity remains despite challenging conditions
Although we have seen comparisons made with the previous real estate downturn that followed the financial crisis in 2007-08, the situation today is different in several respects. Levels of leverage were not as high prior to the current market downturn and many borrowers continue to retain some equity in their investments. Moreover, the monetary policy environment is different owing to high inflation, which has led central banks to increase interest rates despite fears of recession. As a result, new loans will be more expensive than they have been for several years.
The aftermath of the financial crisis also saw greatly reduced liquidity in debt markets, but we do not believe this will be the case this time around, especially in Europe. It is true that liquidity in debt markets and the wider real estate market has been impacted by the economic slowdown, not helped by recent volatility in financial markets after the failure of Silicon Valley Bank. However, banks are better capitalised than they were fifteen years ago and the range of non-bank lenders has increased markedly. This provides borrowers with many more options than in the past.
In the UK and Continental Europe, debt funds have become active lenders across all sectors, while insurance companies are also originating more loans. We are seeing most liquidity in the Residential sectors (i.e. lending on multifamily residential and student accommodation assets), but there is also liquidity for lending on Logistics and Life Sciences assets. Hotels and other operational assets rank lower than this at present, while Office and Retail are attracting less interest at present. Nonetheless, we continue to be able to price loans on attractive terms across all sectors, while existing lenders remain supportive at loan maturity for most asset types, albeit at slightly lower LTVs and slightly higher margins.
The European countries included in our sample were as follows: Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Netherlands, Norway, Poland, Portugal, Spain, Sweden and UK. No data was collected in Q1 or Q2 2020.