A double-dip recession could expand real estate debt funding gaps across Europe. Hans Vrensen and Nigel Almond put these absolute numbers in perspective
Over the next three years, $2.6trn (€2trn) in commercial real estate loans are due for refinancing, representing 38% of all outstanding commercial real estate debt globally. In Europe, this proportion is nearer 50%, since the impact of recent roll-overs and loan maturity extensions means around €900bn in European commercial property loans will mature in the same period.
Global financial markets remain in turmoil, causing banks' wholesale funding channels to remain blocked, while stricter capital reserve requirements and other regulatory pressures are increasingly forcing them to de-lever. As a result, we expect that the impending wall of commercial real estate refinancing requirements will place even greater pressure on the markets to find a resolution.
It is at the point of refinancing that a loan event or default is likely, which is why we focus on the debt-funding gap - the difference between the existing debt balance, as it matures over time, and the debt available to replace it.
Over 2012-14 we estimate the global debt-funding gap will total $142bn, a 27% reduction on May 2011. Asia Pacific's gap has improved significantly, while in Europe the debt-funding gap remains elevated and has shown little improvement on six months ago.
The UK has the largest absolute debt-funding gap of $44bn. Spain has the second largest at $29bn, followed by Japan at $21bn where the debt-funding gap has fallen precipitously from $78bn. This reduction mostly reflects changes to our assumptions, based on new data on local lending practices. Ireland's debt-funding gap remains high at $14bn. France ($8bn), Italy ($7bn) and Germany ($6bn) have the next biggest absolute debt-funding gaps. The remaining $15bn is dispersed across the rest of Europe.
Measuring the debt-funding gap of a country relative to the size of its invested stock is a more reliable measure of its exposure. On this basis, Ireland remains the most exposed market, with its debt-funding gap equivalent to 21% of its invested stock. Despite having a relatively small absolute debt-funding gap of $2bn, Hungary has a relative gap of 8%. This is followed by Spain at 6% and the UK at 5% .
The weakness in Europe's debt-funding gap is not surprising given the wider sovereign debt issues. With risks clearly on the downside, what would happen in the event of a disorderly default by several European states leading to a double-dip recession? Such a downside scenario would have a negative impact on our capital value forecasts through lower rental growth and higher yields.
We have run our models with these lower capital value forecasts. On this basis we would see a 78% increase in Europe's debt-funding gap from US$122bn to $217bn. France sees its debt-funding gap rise from $8bn to $36bn, and Germany's rises from $6bn to $17bn. The debt-funding gap in Spain also escalates from $29bn to $47bn and equivalent to 10% of its invested stock. In contrast, the UK's funding gap only increases by $49bn, just 6% of its invested stock, as it is less exposed compared with core European markets.
Many banks are committed to exiting their non-core commercial real estate loans. Further pressures are building from the EU for banks to raise their tier-1 capital ratios. This is leading many to look at loan or asset sales as a means of reducing risk. By packaging loans into a portfolio, banks can shrink their balance sheets more effectively than they would by working through individual assets.
During the latter half of 2011, a number of loan portfolios, many in excess of €1bn, were either being sold or being prepared for market. These included sales by Intesa Sanpaolo, Lloyds Banking Group, National Asset Management Agency (NAMA), Royal Bank of Scotland (RBS) and Santander. Demand for such product is also strong. Not just from the traditional opportunity funds, but also more institutional capital, as evidenced by China Investment Corporation providing the equity behind Blackstone's planned acquisition of RBS' Project Isobel, and Kennedy Wilson's acquisition of a portfolio from the Bank of Ireland, supported by institutional capital.
Globally, we estimate there to be $399bn of equity available under our base scenario, which is nearly three times the debt-funding gap of $142bn. But there are regional variations. In Europe the amount of available equity is just $156bn, a mere 28% above Europe's debt-funding gap of $122bn. This could easily be reduced if market conditions deteriorate. In Asia Pacific available equity is more than four times higher than the debt-funding gap. In North America, there remains no debt-funding gap to be bridged.
While potential equity to bridge the gap may be sufficient, will debt be available at refinance? Announcements from Eurohypo and Société Générale that they are suspending new lending reinforces the importance of lending capacity in today's market.
Our model assumes debt is available at refinance. Therefore, any restriction in the availability of debt could derail the recovery in lending markets. We would not be surprised if more banks are quietly imposing restrictions on new lending at just the time when a number of loans are due for refinance.
In many cases lenders are still committed to refinancing existing loans, assuming no further significant deterioration in the market environment. As pressures mount on Europe's banks to reduce their real estate exposures we expect the sale of loans to increase, particularly whilst demand remains strong for such portfolios.
Hans Vrensen is international director, global head of research, and Nigel Almond is associate director, forecasting and strategy research at DTZ