Comparing COVID-19 to the Global Financial Crisis of 2008

The Edmond de Rothschild group has been active in financing for over 250 years and has witnessed many cycles and crises throughout history. For several years, lenders and borrowers have acknowledged that they were operating in an unusually extended property cycle. We see the Covid-19 pandemic as the trigger of the long-anticipated market correction.

This will not be a repeat of the 2008 real estate-led Global Financial Crisis, with both the real estate and financing markets in better shape than 12 years ago. While Covid-19 has caused a demand-side shock, different root causes of the crises and today’s lower interest rates make comparisons with 2008 of limited value. Compared to previous cycles, vacancy rates are at all-time lows in many markets and there has been limited speculative development across many markets. Hence the supply side risk is, generally speaking, limited.

Following 2008, with banking regulation tightened and investors looking for stable income and portfolio diversification, the real estate debt market grew significantly, providing reliable income streams, attractive risk/return profiles, and greater downside risk protection than equity investments.

ASSESSMENT OF THE IMPACT OF COVID 19 ON REAL ESTATE MARKETS AND REAL ESTATE FINANCING MARKETS

While H1 market data indicates a downward-shift in property values, there is still a lack of transaction evidence. It is, however, fair to assume that there will be declines in rental income across the market in 2020, impacting valuations in the short-term. Rental decline will vary across sectors, with the retail and hotel markets hit hardest. The impact on the office sector will depend on tenant mix and location while residential and logistic are expected to be fairly resilient.

Once the peak of the crisis has passed, we expect transaction activities to resume as investors look to take advantage of favourable pricing and, given the attractive yield spread and income characteristics of real estate in general, we expect good investor appetite.

As real estate markets in Europe adapt to the new situation, there will be fewer financing deals than previously, with transactions taking longer to secure finance. Both borrowers and lenders are, increasingly, taking a wait-and-see approach. At the same time, some banks and debt funds are still holding loans issued before Covid-19 due to an inability to sell them into institutional debt markets, reducing liquidity within the financing markets.

In general, margins have increased for senior and junior debt and the spread of lending terms between property types is likely to grow. It should be remembered that pre-pandemic loan margins for retail assets were already on the rise.

Clearly, we are now in a lenders’ market and the market correction will be a catalyst for further growth of the debt funds in Europe. One of the big advantages real estate debt funds have over banks is the ability to adapt and provide tailored financing solutions to borrowers as the market changes.

Increasingly under pressure, banks are likely to further reduce their exposure to real estate. With many borrowers preferring whole loans with a single source of capital, this creates tremendous market opportunities for real estate debt funds who can write loans at higher LTVs than banks.  With no legacy loan book positions and an ability to focus on new deals the Edmond de Rothschild Real Estate Debt Team is currently working on over €500m of new debt investments. The EDR Real Estate Debt Team is part of the Real Estate Investment Management Division of the Edmond de Rothschild Group and has more than 130 people working across Western Europe managing more than €10bn of real estate assets. EDR is currently working on its first high yield real estate debt fund targeting a launch in Q4 2020.

WHY INVESTORS SHOULD LOOK TO DEPLOY CAPITAL INTO THE REAL ESTATE LOAN MARKET

Edmond de Rothschild group envisages that, because we are now in a lenders market, the next two years will provide excellent opportunities for debt investing, with loans made at lower LTVs and higher pricing than before the pandemic.

Given the reliable income stream from the loans and the high risk-adjusted returns real estate debt will be one of the most attractive and resilient investment sectors, particularly as debt investors will benefit from security packages and loan covenants offering downside risk protection.

Providing flexible financing solutions and a smooth underwriting process in comparison to banks, debt funds will be in an excellent position to provide attractive financing solutions to borrowers.

One certainty is that the demand for capital will remain strong, initially driven by refinancings but followed by acquisition opportunities as the pandemic fades. Depending on the scale of the impact on the real economy, there are likely to be disposals of loan positions or loan portfolios by banks or other debt funds that could offer potentially very attractive (secondary) investment opportunities.  This happened after 2008 and there is a good chance that it will happen again in the post-pandemic market.

By Ralf KIND – EDR REIM – Head of Real Estate Debt