Renewed Activity, Flight to Quality in European CRE Finance Market

September 16, 2020

Takeaways:

  • Lending activity is increasing, especially among U.S.-based lenders
  • Flight to quality continues in sponsors and product
  • Offices attract financing, while retail and hotel struggle
  • Sponsors look to extend loans to ride out the pandemic
  • Pent-up weight of capital on the sidelines likely to drive acquisition activity

New lending activity has picked up across Europe, with one of the first commercial mortgage-backed securities deals closing in mid-August on an industrial portfolio in the United Kingdom. Germany, Netherlands and Spain have also seen a fair number of transactions, with several large industrial and logistics portfolios coming to market. Traditional U.S.-based lenders have been relatively active compared to some of the private equity and investment banks, but caution prevails across the board, with a flight to quality in both sponsors and product.

Office Rebounds

High-end office developments in London’s West End are attracting financing. They tend to benefit from long-term leases and an acute lack of supply. Office parks and villages on the urban fringe are also enjoying a renaissance, as occupiers disperse their teams to diverse locations to minimize commutes on public transit and accommodate social distancing.

Hospitality & Retailers Struggle

The hotel and high-street retail sectors continue to struggle, with luxury properties in London expected to remain closed until September and supply continues to expand, with five to six new developments set to come online in the next 18 months. The U.K. outlook is extremely challenging, as tourist traffic from the U.S., Russia, Asia and the Middle East, which sustains the luxury market, has largely evaporated. Hospitality may experience a double blow if a second wave of COVID-19 decimates holiday shopping, parties and events. We could see a significant number of shopping centers coming to market by year-end, providing price discovery, followed by development to repurpose and reposition these assets.

Sponsors, Lenders Collaborate to Find Solutions

Some sponsors are exercising the option to extend existing three-year loans and lock into five- and even six-year terms to ride out the COVID-19 storm. Delinquencies are declining, and the avalanche of defaults anticipated earlier in the year have not materialized. Overall, a spirit of cooperation still prevails, with lenders continuing to waive financial covenants in cases where sponsors have equity in the structure, or the means to augment it. But patience with borrowers may wear thin by the first quarter of 2021 if the situation has not improved, and a spike in asset sales would be likely.

What’s Next?

The pent-up weight of capital on the sidelines is a key driver of increasing acquisition activity. The near-term has been characterized by a bit of a stalemate, as credit committees aren’t eager to approve deals without a discount to pre-COVID values, resulting in significant bid-ask spreads. Some pension funds have been idle for the last five months amid lockdowns, creating momentum to invest to meet investment target allocations, particularly if they manage closed-end funds with a backstop date. SitusAMC expects to see accelerating acquisition activity in the fourth quarter by experienced debt-driven investors seeking low-risk opportunities with high-quality, stable cash flow. The size of the capital injection will depend on whether Europe experiences a second wave of coronavirus infections, or a vaccine is made widely available.

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