COMMENT: Somewhere between a rock and a hard place

There is no getting away from the fact that increased competition, and substantially higher costs, will have an important bearing on the competitive landscape for real estate lending in Europe going forward, writes Joe Valente, European head of research for real estate at JP Morgan Asset Management in a commentary.

The fact that different types of lenders are now being forced to play to different sets of rules will not only increase the heterogeneity of the lending market in different countries, it will inevitably encourage lenders to take additional risk.

The aftermath of the global financial crisis resulted in a lending landscape comprising, on the one hand, those lenders classified as 'systematically important financial institutions' (many of the larger banks but also companies such as GE for example) whose cost base has increased significantly as a result of regulation and, on the other, a range of alternative lenders operating from a much lower cost base as a result of much less regulation.

It is no surprise, therefore, that according to the Financial Stability Board (an international body that monitors and makes recommendations about the global financial system ed.), the non-traditional lending sector has ballooned over the last few years to command assets of $75 trn (€68 trn). PERE estimates that private real estate debt funds alone have raised more than $115 bn since 2008.

The traditional banking sector is faced with a panoply of new regulation forcing banks to increase their equity. At the same time, regulatory, capital, liquidity and compliance requirements are adding to costs at the very moment when the rise in competition is forcing lending margins down - 12 months ago, good quality offices in Germany were being financed at 130bps, today its closer to 70-80bps.

In the UK bank lenders accounted for around three-quarters of all real estate lending before 2008, but that has now fallen to just 40% of total. Ireland and Spain have also seen a significant rise in alternative lenders, in part because of the severe cut-back in activity from the traditional lending sector. The exception is Germany where the Pfandbrief market has helped to keep out a good number of alternative lenders. The question is for how long?

As the level of competition increases, some debt providers will inevitably exit the market (GE for example) or they will be tempted, or forced, to take on higher risk – speculative development finance is no longer rare, the most conservative of insurance groups are now willing to lend in Southern Europe, lenders have moved to specialist sectors and Tier II and III markets, moved to non-core and structured debt products, all with the aim of generating the sort of returns promised to their investors and shareholders.

They are taking higher risk and it is against this background that the recent broadside from the Bank of England should be heeded. It warned lenders of falling underwriting standards in the commercial real estate market – a red flag if ever there was one. The report goes on to point to the fact that underwriting standards have 'loosened' recently and whilst most banks remain resilient in recent stress tests, the BoE will 'consider appropriate action if underwriting standards threaten to evolve in an unsustainable way'.

Joe Valente
Head of Research Real Estate
JP Asset Management