At the beginning of the pandemic, lenders did not expect distress levels to be anything like the global financial crisis in 2008/2009. We can, and continue to, remain optimistic in this regard as we have still not seen the levels of distress we might have expected after months of shut down. Lenders have been supporting borrowers, and in general, we have seen less loans in special servicing or foreclosure scenarios than may have been predicted.
The distressed assets we are now seeing in Europe and the U.S., and likely will continue to see, are those assets that were already being challenged pre-pandemic, such as retail.
The question remains, as courts start to open back up and government protection ends, will more distressed assets come to light? The possibility of course exists, and may be particularly relevant for the already struggling asset classes, as those tenants will still be forced to pay their rent or else a paying tenant will be found.
Many of the lender clients we work with are continuing to lend on the asset classes they lent to before. However, they have become more sponsor and asset driven. Understandably, lenders will be approaching retail with caution unless repurposing is an option if retail, as the primary use, is no longer viable.
Office space is the asset where there is a cautious appetite as no-one can predict whether in a few years, more or less office space will be required as people continue to work from home. While the cautious approach is to assume that less office space might be needed, in Germany for example, lenders have more appetite as they think more space will be needed to maintain social distance and other COVID-19 protective measures.
The debt funds in the U.S. are now focusing on multifamily (residential) and industrial asset classes, but are recognizing that they may need to go covenant light to obtain these deals due to increased competition with the banks. Further adding to these difficulties in obtaining these deals, if these assets are being sold, they are often sold on a confidential basis. Nonetheless, U.S. debt funds and bank lenders may still be willing to lend to some of the asset classes which may be “riskier” in the context of a post-pandemic world (such as office space), depending on the status and financial wherewithal of the sponsor. For example, in the past year, some sponsors and companies have received loans of around the US$1 billion mark for office buildings in New York City.
In the UK, lenders are optimistic that after a difficult time, student accommodation will return to normal now that the new academic year has begun.
The asset classes which remain a favourite with lenders are beds, sheds, meds, and watts.
Why have some development projects paused?
A number of construction projects have been paused or delayed during the pandemic, however, across Europe and the U.S., this is primarily down due to increased construction costs and the lack of skilled workers, and not necessarily due to a lack of funding. Some borrowers are therefore moving away from investing in countries which have been hit hardest by these construction challenges, such as Germany.
Development finance is definitely on the menu for the non-traditional lenders when the market or the asset is deemed too risky for the banks. If it’s not already on the menu, then it should be.
Banks versus alternative lenders
In the U.S., alternative lending in commercial real estate represents approximately half of all lending and the UK is following that trend. Interestingly, for UK deals, the debt funds are in Germany but they are still not able to take center stage as bank lending is still available at a good price. In Spain, the conservative borrowers still prefer to work with the banks.
Environmental, social, and governance (ESG)
ESG is key for investors and therefore is being forced to the forefront of the minds of lenders and borrowers. Some lenders are offering discounts on margins based on borrowers delivering on ESG strategies. For some lenders and borrowers it is still early days for them to be enthused by ESG but they know this has to change. While ESG can be a consideration for deals stateside, especially if a lender or investor is subject to ESG requirements or target in another jurisdiction, in the absence of any formal federal or state ESG mandates, most U.S. deals continue to be driven by economics and investor return. Accordingly, it appears that U.S. debt funds, as well as other U.S. lenders that do not operate outside the country may take a reactive, rather than proactive, approach to ESG.