Real estate lenders fear their loanbooks will start to come under stress by the summer in the third quarter of 2020 if economic activity does not begin to pick up before then. Speaking in mid-April, four to six weeks after European governments began to go into lockdown, shutting off much economic activity, the lenders that PropertyEU contacted were reporting being ‘in pretty good shape’ after the end of March quarterly interest payment date (IPD).

With companies generally having traded well in the first two months of 2020 before the virus struck Europe, tenants seem to have had some liquidity to tide over the second quarter. The loans expected to show stress first are to retail and hotel borrowers where rent collection was lowest at the end of March. Intu reported it collected 29% of rent due; Hammerson secured 37% in the UK, its biggest market; while Knight Frank said landlords received only a third of the £2.5 bn quarterly rent due on UK shops.

Mitigation measures
In the first weeks of the crisis and into Q2, debt financiers were kept busy reviewing their portfolios and responding to requests from borrowers that need lenders’ approval for a range of mitigation measures: from closing hotels to approving tenant requests to switch to monthly rental payments, or to defer and roll up rent.

‘I would say for offices, the rent collection rates are pretty high, though I can’t give you a percentage, but way, way higher than for retail,’ says the head of continental debt investing at one institutional lender. He adds that his business – which has very few retail or hotel loans – has had ‘zero conversations about deferring coupon payments’. Other requests to lenders include forward-looking covenant waivers around interest cover or loan to values.

Michael Kröger, head of international real estate finance at Helaba, says: ‘What we and everyone else are doing, is going through our portfolio loan by loan to see what the possible impact is. We are trying to anticipate certain developments, not wait to be surprised at the next covenant test.’

Lenders say that for construction loans, the picture varies depending on where projects are. Germany has allowed sites to remain open the whole time, although there are reports of delays caused by getting materials to site. Some UK construction is ongoing and progressing while other sites are closed. In Spain, where the government initially closed all sites, the restriction was lifted on 13 April.

‘For student accommodation, the big question mark is: what will happen in September?’ one lender comments. ‘In the case of buildings that are up and running and fully operational, most of them have got similar levels of forward bookings for September as they had last year. But in some ways it’s a bit of a false comfort because generally students don’t have to pay a big deposit, so they are waiting and seeing, if it doesn’t cost much to keep their options open.’

The length of the lockdowns is businesses’ most crucial worry. As one institutional lender says: ‘Regardless of the sector, the borrower, the building – anything – if this lockdown goes on as it is now until the end of June a lot of tenants are just not going to be able to pay the rent in any sector. If it goes on longer, then come September, there are tons of businesses that are going to go bust.’

Helping hand
Meanwhile, central banks and regulators have told banks to be helpful. On 2 April, the European Banking Authority said it sees moratoria on payments as effective tools to address short-term liquidity problems for businesses. Short-term is the key expression, but in those cases, the guidelines are that payment freezes do not trigger classification as forbearance or distressed restructuring if based on countries’ (different) measures for supporting economies. The Basel committee has delayed implementation of Basel III by a year.

Similarly, for refinancings of loans falling due, the anecdotal evidence is of lenders granting short-term extensions of three to six months. The feeling is that everyone is in this together, in business just as in the community, so long as all parties act with transparency and fairness. Possibly it helps, as commentators have pointed out, that banks are not the bad guys this time as they were in the global financial crisis. As Francesca Galante, co-founder of European debt advisory firm First Growth, summarises: ‘For existing loans experiencing stress, in the vast majority of cases both lenders and borrowers are, for the time being, taking a cooperative approach to facing or anticipating difficulties.’

One area of potential distress that is already evident in real estate finance is the levered debt fund lenders. Most – although not all – European debt funds do not use loan-on-loan funding to boost their returns. Therefore, Europe may be spared this headache experienced by US mortgage REITs, where the listed debt funds managed by the likes of Starwood and Blackstone have seen share prices hammered. To compound the situation, as one London-based broker points out, these vehicles were also big financiers of construction loans and hotels.

New loan requests are ‘rare’ – and pricing has gone up in line with higher risk
New lending opportunities are slowing down rapidly, available leverage is dwindling in anticipation of falls in asset values and the cost of debt has gone up. ‘We continue to be open for business selectively and we are closing loans. However, the pace of transaction activity has slowed, and totally new requests are rare,’ says Helaba’s Kröger.

‘We haven’t had a lot of requests...on the new deal front it’s pretty slow if I’m honest,’ agrees another lender.

Financing deals have been stopped or put on hold, including some at a very late stage. However, First Growth’s co-founder Cyril de Romance observes most lenders are honouring commitments. ‘Most have been willing to honour their commitments to clients and are completing transactions, albeit sometimes with adjustments in terms,’ she says.

Anything not already committed is being repriced. Bankers say bank funding costs immediately went up by 30-80 basis points when the crisis hit and the cost of senior debt for core property has probably risen by circa 50 bps. Customers hoping to refinance an existing bank loan elsewhere for a better deal are disappointed: ‘We are not compromising – and that is something I hear across the industry. Banks are not compromising,’ one lender observes.

Investors are scrambling to draw down corporate facilities as fast as possible to maximise their own liquidity and avoid higher funding costs. ‘Every company, from biggest to smallest will be doing this,’ adds another lender.

The eurobond markets remain open, even if national markets are paused; Unibail-Rodamco-Westfield issued €1.4 bn of notes several weeks into the crisis but at a coupon of 2.625% for 10-year money compared to circa 1% for 12-year debt a year earlier.

One broker says: ‘The ability to secure new financing unless you are a blue-chip sponsor, particularly if that financing requires someone to securitise or syndicate a piece of it, is not going to happen. ‘Lots of banks can write €150 mln loans and hold them on their on books, and so for good sponsors, terms are still available. [The margins] are slightly wider than before. But they aren’t available for the general market. So that is going to have an impact on deal volume going forward.’

Roland Fuchs, head of real estate debt at Allianz, explains: ‘The real estate risk and the tenant risk have been simultaneously impacted by the current situation. Consequently, the risk-adjusted returns have changed and the loan pricing will therefore change too.’

While yields for investment-grade real estate corporate bonds had increased by over 100 bps by the end of March compared to a month earlier, structured finance spreads have blown out more. Paul Coates, head of EMEA debt & structured finance at CBRE, points to BofA Global Research figures showing European AA CMBS spreads rising to 400 bps. ‘We have seen a near-halting of the CMBS and syndication markets, which are effectively closed for new issuance,’ he says.