Excessive volatility spooks European debt markets
There is still liquidity in the market, but lenders are more wary and loan sizes tend to be smaller. Levels of distressed debt are also increasing, reports Nicol Dynes.
Excessive volatility is spooking the real estate sector and creating significant problems in the market.
“Volatility is killing us,” says Duco Mook, head of treasury and debt financing for EMEA at CBRE Investment Management. “It is not the increase in interest rates [that is the problem], but the volatility, which makes it difficult to underwrite debt terms and is a real dealbreaker.”
The market is finding it difficult to adapt, as it is impossible to forecast where interest rates will land in the short to medium term. “The markets are shaky and there is less investment activity than we are used to,” agrees Barkha Mehmedagic, global head of institutional sales and group treasury at Commerz Real. “Banks analyse the quality of each asset more and the size of loans has decreased. I hope there will be less volatility in the months ahead.”
Flight to core
There is a flight to core in every asset class and lenders are increasingly risk averse, Mook adds. “The syndication market is still on hold, so they have difficulty in providing loans, but ultimately they still have a balance sheet to deploy and they are willing to service their clients.”
There is still liquidity in the market, but lenders are more wary and loan sizes tend to be smaller. “We are positive on liquidity for the year ahead, but with caution and realism,” says Mook.
Germany presents a particular problem. Alternative debt providers with relatively little experience have boomed in the past few years. Now, as market conditions have changed and the levels of distressed debt rise, they face a reckoning that is likely to lead to an increase in non-performing loans (NPLs).
“In Germany, banks are complacent and we expect alternative lenders’ NPLs to reach €16 billion. Together with the estimated €38.1 billion from the banks, we expect a total German NPL volume of around €54.1 billion in 2024,” says Oliver Platt, managing partner of Arcida Advisors.
“NPLs are set to explode, but no one seems to be noticing the gathering storm in the German banking sector. There’s a risk they won’t be able to provide loans for new businesses.”
These shifts will have a lasting impact, says Karolis Adlis, executive director of European investments at WP Carey. “I’m bullish on the investment market, but I am very bearish on the economy. The world will be very different.”
Expectations that the markets will change soon are misguided, because the environment has changed drastically, he warns.
Not the norm
“We’ve had one of the longest bull markets in modern human history since 2011 and we have a generation of people who grew up in a low interest rate environment and don’t realise that it’s not the norm,” says Adlis. “I think we’re returning to the norm now, which is a high interest rate environment.”
As the cost of debt rises, the market and the pricing of real estate transactions change as well. This creates opportunities to help clients refinance their debt, says Adlis. “Private equity companies have bought a lot of businesses on short-term, cheap debt that they need to refinance now, so we’re going to be there to provide that financing by doing sale-and-leaseback transactions. This is going to be good for us.”
‘Volatility is killing us. It is not the increase in interest rates [that is the problem], but the volatility, which makes it difficult to underwrite debt terms and is a real dealbreaker.’
Duco Mook, CBRE IM
Refinancing a big portfolio would be difficult currently, but “if you’re an equity player, there’s plenty to buy out there”, says Mehmedagic. “It’s an interesting and dynamic market.”
But because of the shift to core assets in prime locations and the focus on residential and logistics, often even equity investors cannot find the right product to buy, says Mook. “It’s easier said than done, and despite adjustments, there is still a gap between the asking price and what people are willing to pay.”
ESG a prevailing theme
Across countries and asset classes, ESG has become a prevailing theme in the market. “Investor sentiment has really changed,” says Mehmedagic. “ESG is now an absolute must. You must have a strategy in place to turn brown to green and light green to dark green. It’s no longer just about questionnaires and certifications.”
It’s not about box-ticking, but rather about rigorous due diligence on assets to ensure that a portfolio is resilient.
“Nordic investors only buy green assets, so we’re motivated to be greener and our interests are aligned,” says Adlis.
WP Carey also issues green bonds, which have become a popular financing instrument in the past few years.
“Green financing has grown. Now close to 50% of debt has an ESG angle, not just environmental, but social as well, because the market demands it,” says Mook. “ESG now needs to be embedded in your system, because investors are asking for it and lenders are asking for it. It’s a theme that’s unavoidable.