More confident lenders face a market split in two

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Investment

The latest BF.Quartalsbarometer suggests that German commercial-property lenders are feeling considerably better, though it does not mean they are willing to lend to much more of the market. The index rose to -12.3 in the third quarter from -26 in Q2, a substantial improvement. Financing conditions, previously described as deteriorating, are now regarded as broadly stagnant, while expectations for new business have strengthened modestly. Risk minimisation nevertheless remains by far the most important objective governing new lending.

That contradiction shaped a subsequent Handelsblatt webinar, attended by REFIRE. The financing market is improving, but principally for assets and borrowers lenders already regard as safe. Banks are competing for a limited group of cash-generative properties and well-capitalised sponsors while spending increasing amounts of time managing loans inherited from the cheap-money era.

Dirk Jörns, who leads professional residential-property lending at Berlin Hyp, described banks as operating in two markets at once. Existing loan books require analysis, negotiation, restructuring and extensions. In new business, lenders converge upon assets with strong and sustainable cash flows, backed by sponsors with sufficient capital to contribute more if circumstances deteriorate.

"Every capital provider is chasing them," he said. The market appears highly competitive at its strongest end, but access falls away sharply beyond it.

Residential, logistics and, increasingly, hotels can still support larger financings where the income is dependable. Opportunities exist elsewhere, but Jörns said the division between good and bad risks had become considerably wider. Office finance remains particularly dependent upon location, building quality, adaptability and the sponsor's ability to manage the asset.

Financing now follows the quality of the property rather than creating that quality through readily available leverage.

The legacy book has years left to run

For existing borrowers, debt-service capacity has replaced rising collateral values as the central test. Properties financed when interest rates were negligible must support substantially more expensive debt from rental income that has not necessarily risen at anything like the same pace.

That gives management performance much greater importance. Owners must work harder upon occupancy, rents, costs and capital expenditure to generate the cash flow lenders require. Where the figures still do not add up, additional equity, a partial sale, restructuring or an eventual loss becomes unavoidable.

Francesco Fedele, chief executive of BF.direkt, warned borrowers not to assume that repeated loan extensions will continue indefinitely. Owners approaching maturity should begin discussions early, establish their legal and financial options and determine whether an alternative lender or temporary bridge can provide a viable route forward.

The difficulty is unlikely to pass quickly. Steffen Sebastian, professor of real estate finance at IREBS, expects refinancing problems to continue for at least another five years and possibly longer. Loans carrying ten-year fixed rates agreed five years ago were written during the low-interest period. When they mature, some borrowers could discover that financing costs have quadrupled while amortisation, rent growth and value appreciation have remained modest.

A property that previously supported its debt can then begin consuming cash every month. Somebody must fund the difference: the owner through additional equity or, where that is unavailable, the lender through a restructuring or write-down. Jörns reduced the problem to two constraints: operating cash flow often cannot carry the necessary amortisation, while the transaction market has removed the exit upon which many business plans depended.

Further insolvencies are therefore likely. Fedele cautioned that the prominent failures receiving press attention represent only part of the market; numerous smaller and medium-sized developers can disappear without becoming national news. He saw no present reason for that process to end.

Failures can nevertheless perform an uncomfortable economic function. Projects and land bought at prices established during the previous cycle may remain stranded while owners and lenders avoid recognising their current value. Insolvency forces that question, allowing sites and schemes to return to the market at prices more compatible with present construction and financing costs.

Stable banks can sustain an unstable adjustment

The reassuring part of the discussion concerned the lenders themselves. Germany is experiencing a severe property correction and refinancing shock, but not, so far, a banking crisis.

Sebastian contrasted the present cycle with 2007 and 2008, when property losses destabilised financial institutions and threatened the wider system. Banks are taking write-downs today, and the Bundesbank continues to identify material property risks. Yet stronger capitalisation and post-crisis regulation have allowed lenders to absorb losses without producing another financial-stability crisis.

Jörns said banks had maintained comparatively stable capital ratios and made provisions for the present difficulties, leaving them able to pursue new business. Fedele agreed that individual lenders may have made poorly allocated loans, but saw no evidence of a sector-wide conflagration.

That strength is good news for financial stability but does not remove the losses embedded within individual properties. It gives banks time to negotiate, extend and restructure rather than forcing immediate disposals. The absence of a banking crisis may therefore make the property adjustment more orderly, but also longer.

Political uncertainty supplies another reason for selectivity. Fedele said the expropriation debate had already been incorporated into international perceptions of German risk before the vote. “I get calls, I get calls,” he said, describing foreign partners’ bewilderment at the country’s political extremes. That reaction was not fully captured by a survey completed on 8th September, before Berlin’s election, but it remains secondary to the more fundamental division already visible in lending.

REFIRE: The BF.Quartalsbarometer records a genuine improvement in lender confidence, while the Handelsblatt discussion reveals just how unevenly that improvement is distributed.

Banks have sufficient capital to compete vigorously for properties with dependable income, defensible uses and sponsors capable of supplying further equity. That does little for assets whose cash flow cannot carry today's debt costs or for borrowers relying upon values and exit assumptions inherited from the previous cycle.

The barometer therefore says more about the confidence of lenders than about the recovery of the properties they financed. German real estate credit is becoming more available without becoming broadly accessible, while the refinancing reckoning beneath it may still have at least five years to run.