Borrowers who need to refinance operational assets like hotels and coworking offices are finding liquidity severely curtailed.
When debt adviser First Growth Real Estate began a search a year ago for a lender to refinance a trophy Italian hotel, there was good interest from foreign banks.
But then Covid-19 hit. Almost at once, financing operational assets started to become more difficult as hotels across Europe were forced to close.
The previous lender on the five-star Park Hyatt in Milan’s historic district on via Tommaso Grossi is understood to have been Deutsche Bank. When the First Growth team recently successfully refinanced the asset, it was with a club of two locally operating banks, MPS Capital Services Banca (MPSCS), the Florence-based corporate banking arm of Monte dei Paschi di Siena, and UniCredit.
Domestic lenders
Cyril de Romance of First Growth says that as the pandemic has continued, the firm has found working with local banks is the best way to get all but especially operational asset classes financed. ‘It is usually easier to get credit committee approval when the committee members are from the region. They can take the train to the asset nearby and see it. They understand the submarkets and the trends there, making transactions easier to underwrite,’ he says.
First Growth found financing solutions from similar, domestic lenders for operating asset transactions that the firm advised on in France over the course of 2020. In one example, a pool of four French local banks refinanced an eight-strong portfolio for KSL Capital Partners when the US-based investor acquired its first significant assets on the continent. They were the five-strong Hotels d’en Haut leisure hotel portfolio bought for cash, followed by three add-on hotels in mid-2020.
Last year the debt adviser also arranged loans for a series of circa €20 mln-€25 mln acquisitions for KKR and Tivoli, to be repurposed to operate as flexible coworking offices, which the investors are agglomerating under the Newton Offices brand. The latest, 3,700 m2 building at the L’Avant Scene complex in Nice is typical and followed spaces acquired in Marseille and Lille. The assets were financed one by one with three different French local lenders.
The €66 mln package for the Park Hyatt hotel was complex, involving three loan tranches including a capex facility and unsecured debt capital alongside the secured, and with the unsecured money coming from Italy’s government-guaranteed emergency liquidity scheme for businesses, SACE.
Francesca Galante, First Growth’s co-founder, says another advantage of using local banks is that they are up to speed on these temporary domestic loan programmes which governments around Europe put in place almost a year ago in response to Covid. France’s government-backed lending scheme is called PGE.
‘They have different time-frames and they all have different functioning,’ she explains. ‘In France the loans have a one-year duration; the Italian loans were more difficult to access but have four to five or even up to six years’ duration. ‘In Italy, not all the banks have been allowed to issue SACE loans. It was not only going to local banks but also to the subset to access that kind of financing.’
Volume restrictions
A drawback for borrowers of dealing with local lenders is that these banks are frequently limited in their capabilities in terms of volume. For medium or larger deals this means putting together a club which in turn implies higher risk of execution.
The result is that the reduction in liquidity is leaving many owners of hotel, retail, leisure and coworking real estate, that is closed or has very limited revenues, in some difficult spots. Their operational assets may be good quality but, unable to trade, as far as many lenders are concerned, they are for now ‘the wrong’ asset class, First Growth says.
‘Similarly to the corporate sector where investors are pouring record amounts of money into “investment grade” debt while none or very limited high yield new issuances are taking place, real estate lenders are shifting their focus to core assets within strong sub-markets (mainly in their domestic market) owned by existing and prime relationships,’ Galante adds.
Knight Frank’s Lisa Attenborough, head of the firm’s debt advisory team, agrees that lenders’ appetite has polarised. ‘At one end of the spectrum, debt finance is readily available for both logistics and residential...In Spain, the Netherlands and Germany, we have obtained post-Covid debt financing terms for logistics assets at all-in rates ranging between 1.50% and 1.80%,’ she observes.
‘Furthermore, due to a sharp decrease in reference rates post-Covid, debt secured against logistics and residential properties is now, in some cases, priced at lower rates than before the pandemic. At the opposite end of the spectrum, lender appetite for retail and hospitality assets has contracted.’
Alternative lenders
Alternative lenders sense an opportunity as banks retreat, but their capacity is more limited than traditional lenders. Meanwhile, borrowers report that banks and debt funds alike reneged on hospitality deals post March 2020, in some cases after committee approval.
Last December, shortly before Covid lockdowns resumed in many countries, PropertyEU reported that Aareal Bank (see below) is still in the market to lend on hotels. The German bank is a big lender against hospitality real estate with €9 bn-worth in its book. ‘Even though hotels are particularly affected by the pandemic right now, we remain ready to extend finance to this sector...leveraging our experience and USPs,’ Christof Winkelmann, member of the bank’s management board, said.
There are other international lenders which also say they will continue to consider financing operational assets. But borrowers and debt advisers have found this potential finance involves higher hurdles, with lenders requiring additional guarantees when providing loans for operating assets such as sponsors able to cover any operating cash shortfall.
‘We have seen lenders requiring either a cash reserve (i.e cash put into an escrow released when certain thresholds are met) and/or an equity commitment letter from the sponsor (i.e the sponsor commits to fund any cash shortfall during a certain period of time and up to a certain amount),’ says De Romance.
Covenant tests
Covenant tests have been another important challenge faced by lenders and sponsors. Borrowers have asked lenders to provide covenant testing holidays for most operating assets facing administrative closure. Lenders also face pressure from governments to accommodate waiver requests as much as possible. Usually for new financings set up in 2020, a covenant testing holiday was agreed at the closing of the loan (usually for a period of no less than one year).
Both First Growth and Knight Frank warn that 2021 could see things begin to get stickier for a lot of investors in operating real estate. Several of the government emergency schemes tapped by investors’ tenants are due to end then, including those in the UK and France, and the first businesses to access them will be due to pay back loans.
Commercial 12-month waivers and covenant-testing holidays agreed last year will also begin to run out. Some of the bad debts linked to provisions made by banks in 2020 are likely to start to be called in. ‘We predict that from March 2021, we will begin to see more activity being driven by lenders looking for borrowers to restructure and recapitalise their facilities,’ Attenborough concludes.
Pandemic will see Aareal Bank swing to a 2020 loss
Aareal Bank warned in January 2021 that it no longer expects to make a profit in 2020 due to an elevated risk of defaults in its provisioned loans.
The German bank is rowing back on its forecast last November, when the real estate lender reported its Q3 2020 result. Then, Aareal had predicted a ‘clearly positive result’ for the full year. Shortly after the Q3 results were published, the bank’s Christof Winkelmann, member of the bank’s management board, told PropertyEU: ‘In our base case scenario, we assume that whilst local lockdown measures might be taken, global economic activity will continue to gradually normalise. We expect a recovery in 2021 and 2022 that will successively gain momentum and breadth.’
Since then, expanded lockdown measures across Europe mean the bank finds it has to move some loans at risk which had been categorised as ‘stage 1’ or ‘stage 2’, to the more serious stage 3 category which means their credit quality is officially impaired.‘Based on current insights, Aareal Bank Group will post a consolidated operating loss in a double-digit million euro amount for the 2020 financial year,’ it said on 17 January this year.‘
This is due to an increase in loss allowance, compared to original expectations. ‘Based on the extended and further tightened global lockdown measures, the bank has generally classified all loans for which liquidity support measures (payment deferrals and liquidity facilities) were granted as stage 2.’ ‘In addition, stage 3 allowance, which is recognised for exposures already deemed to be at risk of default, has been raised in individual cases. Overall, having recognised forward-looking additional loss allowance to a significant extent, the bank is therefore comprehensively taking account of the recent intensification of the pandemic.’
