Gareck Wilson, managing director at loan servicing and advisory firm Solutus, considers the current state of the European commercial real estate lending market, and why there is an uptick in lending in the UK mid-market and indirect lending strategies.
From an economic point of view, we are in a much more stable place than we were 12 months ago. Inflation seems to have cooled quite a bit. The ECB has had a rate cut, but the market was already factoring that in. I don’t think we will have a number of very quick rate cuts that borrowers might have hoped for, but the outlook is now stable. In contrast, if you look back 12 months ago the outlook was uncertain. However, the political landscape also remains uncertain, with the situation in France, US elections and ongoing conflict in the Middle East and Russia-Ukraine.
In the UK, investment activity has certainly increased. We have seen evidence of transaction activity and rebasing of valuations. We are also seeing more activity in Spain and the Nordics region.
In other parts of Europe, France and Germany are still facing challenges. In France, for instance, there was just over £1 billion (€1.2 billion) of transactional activity in Q1 this year, the lowest since 2010, which was at the height of the global financial crisis. It is not to say that lending is not occurring, but a lot of banks are focused more on refinancing, short-term extensions and value-add rather than acquisitions. In Germany, recent examples of increased loan loss provisions for some big German lenders, primarily due to their exposure to the US office market, has impacted their lending activity.
How long it takes for France and Germany to pick up will be interesting because they are two of the largest jurisdictions for commercial real estate lending in Europe. France will probably take a bit longer because of the political instability. But I think as we roll into 2025, we will see things start to pick up in both France and Germany.
Meanwhile, the funding gap continues to exist in the UK and Europe. Recent figures suggest that the forecasted net funding gap across the two regions from now through to 2027 is just under £100 billion. This will continue to have a big impact on the lending market and its evolution.
So, while the funding gap has created opportunity for private credit players, many are still proceeding with caution. They are still doing very granular portfolio management of their books, looking at their loan losses and what difficult loans they may have.
We are currently seeing more loans for stressed situations on our book in the mid-market and smaller end of the market than we do on the larger ticket assets.
When it comes to the average loan size, people have different interpretations of the mid-market. I would put it at below £50 million in loan size, but we are seeing more activity around the lower range of £5million-£20 million. Activity is most concentrated around the living sector such as build-to-rent, senior living, care homes and smaller student accommodation, since there continues to be demand-supply imbalance in the sector.
There is also a plethora of smaller, but experienced developers who are building these projects. That is where we are seeing a bit more stress in the market, as the sponsors of such loans won’t have deep pockets like the larger institutional investors. These loans are typically at a higher leverage point than perhaps what you might see at the larger end of the market. And sometimes, despite the quality of the assets, they can be in more secondary locations. This means that due to the downturn in the market, less well-capitalised sponsors and at higher leverage point, secondary assets will face problems.
When it comes to indirect lending, larger and more institutional debt funds are using back leverage and various types of financing to effectively leverage their funds, which gives them more capital to deploy. This strategy is attractive to lenders because it typically sits in a senior or super senior position. They may be only at 40 percent LTV, for example. And given their position, they are also able to gain exposure to real estate credit without actually having to go out there doing the lending themselves. Moreover, these lenders also get favourable regulatory treatment since they are not providing direct lending.
