By Rob Pike

Executive Director of Risk and Data Reporting

Europe’s real estate financing markets are expected to gradually recover in the second half of 2024. This recovery will be driven by several key factors: the unwinding of interest rates, easing political uncertainties, and an increase in transactions volume that will help reset market pricing.

In the first half of 2024, debt market pricing and liquidity remained relatively stable despite uncertainty regarding the future trajectory of interest rates. However, demand for new lending was subdued as both buyers and sellers hesitated to engage in transactions, resulting in a widening bid-ask spread.

This article explores the outlook for commercial real estate financing in Europe and the UK in the latter half of the year. It delves into sector trends that could indicate a resurgence in finance demand and addresses the refinancing requirements of maturing loans. Additionally, we investigate potential signs of a revival in European CMBS issuance.

Origins of Lacklustre Financing Demand

The sluggish recovery in lending demand can be traced back to the rapid repricing of real estate following aggressive interest rate hikes from mid-2022 to late 2023. High interest rates and lacklustre economic growth created a substantial bid-ask spread between buyers and sellers, leading to the lowest levels of European transaction activity in eleven years, according to MSCI Real Assets. The UK faced particularly challenging conditions, with total origination dropping by 33 percent year-on-year to GBP 32.7 billion, according to the Bayes CRE Lending Report 2023, with the decline even more pronounced among non-bank and insurance lenders.

Over the past twelve months, lenders have primarily focused on refinancing existing loans, with up to 61 percent of portfolios experiencing covenant breaches and defaults, according to Bayes. Transactions are more likely when there is clear evidence of price and valuation adjustments. However, many sellers, burdened by unrealised losses, are reluctant to sell unless compelled by distress, which can trigger price discovery and establish a market floor. The pace of these adjustments varies widely, with the UK market resetting pricing more quickly than Europe. This pricing clarity benefits both investors and lenders, by narrowing the bid-ask spread and stimulating acquisition financing demand. In Europe, however, the slower alignment between buyers’ and sellers’ expectations, limited transactional evidence, and national valuation systems that resist rapid adjustments prolong the price disconnect, thereby stifling transaction activity and dampening finance demand.

As new valuations emerge, some assets risk being left behind if they fail to meet the rising expectations for modern, sustainability-led facilities. These legacy assets are at greater risk of obsolescence, dwindling occupier demand, and very low financing liquidity. Owners lacking capital to upgrade these assets may be forced to sell at discounted prices.

Interest Rate Cuts as the Catalyst

The anticipation of further interest rate cuts extending into 2025, along with a more stable interest rate environment, is expected to boost investor confidence and increase financing transactions in the latter half of this year and into 2025. Lower interest rates are likely to narrow the bid-ask spread, stimulate upward revisions in valuations, and encourage hesitant vendors to bring assets to market.

This, in turn, should prompt side-lined investors to deploy capital, stimulate property transactions, and spur financing demand. Progress will be gradual, reflecting the time required for borrowers to adjust to a more normalised interest rate environment after years of near-zero rates. The debt funding gap for European commercial real estate loans maturing between 2024 and 2026 is estimated at EUR 100 billion, according to AEW, highlighting the significant refinancing needs that could further stimulate financing activity.

Interest Rate Trends and Lender Flexibility in Loan Extensions

Although interest rates are expected to fall over the next 15 months, they remain significantly higher than when the 2021 and 2022 loan vintages were extended. Some limited hedging is anticipated to mitigate declining interest rate risk, and borrowers with equity in their transactions will likely take the necessary steps to secure loan extensions. In many cases, short-term hedging to cover an additional twelve-month extension term could suffice. After this period, longer-term refinancings can be negotiated when interest rates have potentially stabilised at a new, higher floor, which economists predict will land between 3.00 percent and 3.75 percent

Lenders have shown some flexibility, particularly in instances where borrowers are approaching loan-to-value (LTV) covenants. In some cases, lenders are not actively calling for valuations when due, to avoid crystallising covenant breaches. Some lenders are not looking to force borrowers to raise additional equity for a twelve-month extension. We are seeing instances where lenders are assisting borrowers with quality assets to secure anticipated extensions without significant issues, indicating an amenable market environment.

Sector-Specific Outlook

By sector, the logistics market faces the largest refinancing requirement benefiting from deep liquidity as both banks and non-bank lenders are eager to maintain exposure to sectors aligned with long-term global economic trends. Residential and offices properties round out the top three sectors for refinancing needs. Financing liquidity for the residential market is bolstered by supply-demand imbalances across major cities in Europe and the UK. In contrast, the outlook for the office sector remains more mixed, reflecting varying degrees of market confidence and demand. 

Office markets are increasingly diverging between “best-in-class” sustainability-focused modern workspaces, and legacy properties that fail to meet evolving occupier demands and behavioural shifts. Landlords and investors who keep pace with changing office market and sustainability trends will benefit from liquidity from lenders. However, the impact of remote working on vacancy rates and rental growth continues to be felt. A condensed workweek, typically from Tuesday through Thursday, has reduced occupier demand, prompting corporates to reassess their real estate needs. While some companies have found flexible working models sustainable without extensive office space, others face challenges in securing financing for asset repositioning. In the UK, oversupply of office space in regions such as Birmingham, Leeds, and Manchester, exacerbated post-Brexit uncertainties and slow economic recovery following the pandemic, has prompted some owners to attempt office-to-residential conversions. However, refurbishments are often complex, time-consuming, and costly.

Outlook for CMBS Issuance

The European CMBS market in 2024 has seen limited activity, with only three transactions to date. In April, Barclays securitised two five-year loans extended to Blackstone to refinance two UK logistics portfolios, valued at GBP 531.6 million. The UK Logistics 2024-1 DAC was the first ‘true’ CMBS transaction of the year, comprising the GBP 328 million St Modwen facility and the GBP 209.8 million Mileway facility, both secured against prime logistics properties. However, there were two other earlier transactions in the first quarter. The Morgan Stanley Ulysses ELoC 27 transaction was a refinancing rollover of the existing structure, while Barclays’ Vantage Data Centres securitisation is more akin to an ABS than CMBS structure.

The story of the European CMBS market in 2024 so far has been the cause behind such limited new issuance. At June’s ABS conference in Barcelona, there was little discussion about new CMBS origination, indicating the market has yet to reach the threshold where securitising loans becomes economically viable for investment banks. Bondholder demand remains tepid, indicating the CMBS market continues to lag behind the broader recovery in real estate financing. Genuine green shoots in the European securitisation market may not emerge until next year, driven by the timing and pace of interest rate cuts in the UK and Europe, and the subsequent impact on asset repricing, debt margins, and bondholder appetite.

In the meantime, investment banks have been extending considerable loan-on-loan facilities, such as repo warehouse lines, to debt funds seeking back leverage on their originated books. This activity is fostering a secondary market in the loan-on-loan space, highlighting the ongoing challenges and opportunities within the securitisation landscape as the market slowly moves towards recovery. We expect back leverage lending to continue to build momentum as the year matures.

---

Rob Pike, Executive Director of Risk and Data Reporting at Trimont, has over 20 years of experience in the finance industry with a focus on the capital markets and structured finance.

---

CRE Finance Focus is Trimont’s bi-weekly LinkedIn newsletter delivering distinct perspectives on the most pressing topics of today from industry experts. Keep your finger on the pulse of the #CRE market and subscribe today.

Have questions or topics you would like to see covered? Submit them here.