Lenders worried about offices but retail’s making a comeback

Retail is making a comeback but there’s a lot of worry among lenders about the office sector’s prospects, experts agreed at Real Asset Media’s Trends 2023: European Debt, Finance & Investment briefing, which was held in Frankfurt recently.

“The elephant in the room at the moment is the office sector, as according to our numbers it accounts for 30% of the value of the European real estate market,” said Anders Hemmingsen, managing director, European investment team, Strategic Value Partners. “Our house view is that we’re just beginning to see the pain and value destruction in the office sector, there’s quite a bit more pain to come and it’s going to be a persistent theme going forward.”

ESG requirements, which will become much more stringent over the next few years, will accentuate the divide between new, sustainable offices and the rest. There is a need to upgrade non-compliant assets to avoid them becoming stranded, but it is too expensive at current prices.

“I don’t want to scaremonger, but if you take the typical B office building, be it in London, Frankfurt or any European capital, in order to turn it into an A office and meet those ESG credentials then values need to fall between 50% and 60%,” said Hemmingsen. “Obviously it’s going to vary from building to building, but across the board that’s our view. Clearly there’s been nowhere near that much value destruction, so there will be more to come.”

It is already the case that financing is difficult to come by for “brown” buildings or assets in the wrong locations.

“In Germany it is extremely difficult to get financing for a refurbishment,” said Oliver Platt, managing partner, Arcida Advisors.

Like other senior lenders, Berlin Hyp has been concentrating almost exclusively on A assets in A locations. In Germany at present the only financing available is for the “right” offices.

“The gap is widening, which creates a toxic situation,” said Norbert Kellner, head of syndication, Berlin Hyp. “Quite a few players are nervous about what’s happening in the office sector with the working from home trend, because the proportion of office lending in German lending portfolios is big. We can’t ignore that.”

The same polarisation can be seen in the residential and logistics sectors, with an ever-widening gap between modern, ESG-compliant buildings in sought-after locations and secondary assets which are at risk of becoming obsolete.

The divide is very much there in the retail sector as well, said Kellner: “We’ve been cautious on retail for many years, but we still finance a shopping centre if it’s the number one in an A city and if it has been performing well consistently.”

On a more positive note, there are signs that the retail sector has seen most of the value destruction and is now looking promising again.

“As a firm we’ve invested over $1 billion in the retail sector over the last two years,” said Hemmingsen. “We’re taking a contrarian view because we’re starting to see a lot of green shoots, particularly in the UK where a lot of the pain has been taken, both from an investment and an occupational perspective.”