A combination of Covid-19 related capital value declines and more conservative lending will lead to refinancing problems in the coming years, despite moderate pre Covid-19 loan-to-value (LTV) levels compared to the global financial crisis (GFC), according to a new research report published by AEW together with Cass Business School.
The research, which measured the debt funding gap (DFG, or the mismatch between the outstanding principal debt amount with what is available for refinancing) across both the UK and German commercial real estate markets, has identified the biggest gap in the UK, where the DFG is estimated at £30 bn for the 2020-23 period, or 16% of outstanding loans.
This is less than half the £70 bn (or 30%) estimated during the 2008-11 aftermath of the GFC, AEW said.
Unsurprisingly, retail emerged as the most affected sector, accounting for nearly 50% of the UK DFG.
German funding gap
Germany reported a €47 bn funding gap which in absolute terms, is bigger than the UK’s. But, given the larger size of the German market, the DFG percentage of current outstanding loans stands at only 9%.
In the eight years following the GFC, the DFG was bridged by a combination of bank losses from discounted sales of nonperforming loan portfolios (NPL) and loan write-downs as well as implied equity top ups from investors.
Assuming a similar negotiated approach with lenders and investors bridging the upcoming Covid-19 DFG, €36 bn will be needed from investors in the UK and Germany over the next eight years (2020-27) to protect their debt-funded investments.
This will require some tough discussions between investors and lenders, but given the relative, modest system-wide LTVs it seems reasonable that many equity investors will top up to protect their principal investment
Also, German and UK banks have the highest capital ratios in Europe and are better positioned to take losses, which might benefit debt-funded commercial real estate investors this time around.
