Europe’s commercial real estate lending market remains a mixed bag. While there are signs of improved transaction activity across UK, Spain and the Nordics, challenges persist in other parts of Europe, particularly in France and Germany.
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.
Q. Has the macroeconomic landscape become slightly more favourable today for real estate lenders than last year?
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.
Q. Is this more stable outlook reflected in transaction volumes, pricing or fundraising data?
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.
Q. Why are mid-market and indirect lending strategies becoming popular, and are there any specific ticket sizes and sectors where such loans are most in demand?
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.
Q. What are some things lenders should keep in mind while doing mid-market or indirect lending in a softening market?
Due diligence becomes really important in an indirect lending strategy. Lenders need to know who they are providing financing to, their investment strategy, processes and how they manage their book. We provide such backup servicing to various participants in the indirect market, so that in case there is a problem with the originator or the book, there is someone who can step in and manage the book of loans for the lender and provide the loan financing.
There is more focus now on ensuring these backup services can be done effectively, whereas, historically, it was a bit more of a box ticking sort of mandate.
We are also seeing lenders ask for more details such as how the transfer of servicing from the originator to the backup servicer will actually occur, and how we would put it into place.
This is naturally the case when you have softening in the market. It is not dissimilar to 2010, when we had special servicers and CMBS deals.
Back in the early 2000s, people did not pay a lot of attention to how these structures from the US were incorporated into the European CMBS market, which caused many issues. A lot of work was done in the CMBS 2.0 transactions to make sure that servicing and special servicers actually worked properly. I think people are looking at that more closely now.
Q. The European real estate lending market has been going through a period of adjustment. Has this impacted the attractiveness of the asset class?
If you look back to mid-2000s when alternate lenders first started emerging, the lending market in the UK and Europe was dominated by banks. Since then, funding diversification has increased, particularly in the UK, with a greater number of alternate lenders, debt funds, insurers and pension funds taking a far bigger share of lending than the banks that have sort of stepped back.
That diversification is probably less so in Europe, so there is still an opportunity for them [alternate lenders] to be active.
Indeed, a lot of alternate lenders we see in the European debt fund space are London-based.
There is also a growing recognition that private credit remains an interesting investment opportunity, both in comparison to other real estate investment opportunities like listed or direct, but also across asset classes in terms of their risk return profile compared to sovereigns, high yield or corporate debt. The profile for private credit and real estate debt is very attractive at the moment.
Q. What is the biggest key to staying afloat in these challenging times as a loan servicer?
From my perspective, it is all about adding value to your client’s strategy because you have particular expertise. Having expertise is more important in a softening market when you have difficult situations to manage than it is when everything is performing well.
A lot of alternate lenders maintain lean teams and are more focused on strategic decisions and origination. So, in addition to expertise, it is also about providing resources that add value in a cost-effective way.
Q. Which sectors are currently seeing the most robust lending activity?
Fundamentals in student accommodation, senior housing, residential, build to rent are very solid, and there is activity. Logistics and industrial remains fairly robust as well, and there is still demand for prime grade A, new build offices. Earlier this year, for example, we saw Cale Street provide a £480 million development loan for an office property in central London. I think when it comes to office and retail, it is all about having a prime location with prime assets and a strong sponsor.
