Start Revving Your Engines For Distressed Sales Around The End Of Next Year
One of the key questions for those with cash to spend on real estate right now is, when will the distressed sales start? The wake of the 2008 financial crash wiped out many in real estate, but it was a period when fortunes were made as well.
According to a pair of new reports, investors looking to capitalise on distressed sales should be looking to position themselves for disposals to start picking up pace toward the end of 2021 and into 2022. They might need to be brave: As opposed to the period after Lehman’s collapse, the distressed assets for sale might not be ones you want to own.
There are already some significant debt restructurings underway in sectors that have been hit hardest by the impact of the coronavirus, such as hotels and retail.
AccorInvest, a €6B European hotel owner, has appointed Rothschild to advise on a restructuring of its €2.9B of debt, Bloomberg reported earlier this week. UK hotel owners have put up more equity to cure loan covenant breaches on portfolios, public debt filings show.
But in the main, banks have thus far been exercising forbearance, encouraged by governments to extend or restructure loans rather than enforcing and taking control. But as time goes on, the depth of value declines created by the pandemic means distressed sales will come.
“While banks are already undertaking provisioning and seeing subdued equity performance, lending distress may not appear in a significant way until 2021 or beyond,” Knight Frank Capital Markets Research Partner Victoria Ormond said in the brokerage’s Active Capital report. “Several regulatory authorities have also encouraged banks to waive lending covenant breaches where the breach is due to general market conditions. However, in time, there will likely be more loans breaching covenants due to borrower circumstances.”
At that point, the market may see more loan restructuring, enforcement and asset sales, Ormond added. Loans against poorer performing real estate, which struggle to be refinanced, could provide the impetus for more direct property transactions over the coming 18 months or so.
“Because non-bank lenders are not subject to the same regulatory capital rules as banks, many debt funds have higher loan-to-value and risk exposures, so are more endangered by the fallout from the pandemic and may need to manage down their risks,” Ormond said. “Additionally, those debt funds which had purchased non-performing loans from traditional banks may need to reassess their business plans in the light of COVID-19.”
That said, for those non-bank lenders without legacy loan problems, the retreat of risk-averse banks from the real estate sector will provide an opportunity to underwrite loans at margins above those possible in recent years, Ormond added.
A report by investment manager AEW has put a number on the gap between the amount of loans needing to be refinanced in the UK over the next three years and the amount of debt available for refinancing: £30B.
In a report entitled “COVID-19 Pushes Refinancing Issues To Near Half GFC Levels,” AEW used data from Cass Business School to estimate the amount of debt coming up for refinancing over the next three years and the amount that lenders would theoretically be willing to refinance as values drop and underwriting becomes more conservative.
The difference is about £30B, with the biggest gap coming in loans that will need to be refinanced in 2022, making it a prime year of opportunity.
The analysis implies there will be far less banking distress as a result of the coronavirus pandemic than after the global financial crisis: the £30B funding gap is significant, but less than half of the £70B funding gap that arose in the wake of Lehman’s collapse. It equates to 16% of all the debt secured against UK commercial property.
AEW highlights something that might pose a quandary for investors searching out distressed opportunities: A big chunk of the refinancing gap, 45%, will come in the retail sector, where values have fallen furthest and lenders are most conservative. Will investors be willing to pick up the opportunities in this struggling sector? Perhaps the roughly 20% of the refinancing gap accounted for by the office sector, equating to around £6B of loans, will be of more interest.
How will this refinancing gap be bridged? AEW looked to the aftermath of the Great Financial Crisis and provides an analysis that has an implication for the balance sheet of lenders as well as the deal schedule of investors.
“Investors and lenders need to bridge this refinancing gap to rebalance their positions,” AEW Head of Strategy and Research Hans Vrensen wrote in the report. “In this respect, the lender can take write-downs or sell their loan position at a discount. Also, the investor can top up their equity to protect their initial investment against lender enforcement.”
AEW found that between 2008-2011, about 55% of the refinancing gap was bridged by lenders taking loan write-downs or selling loans at a discount, with the remaining 45% coming from equity top-ups.
If the same were true in the period 2020-2023, that would mean lenders taking a balance sheet hit of £16B, and £14B of new cash being injected to top up equity levels.
Some of that new equity will come from existing borrowers. But a lot will come from new investors, too. And that is where the opportunity lies.