The LMA hosted a seminar on 22 September providing an update on developments in the real estate finance market following the Brexit referendum result. A panel consisted of:
- Stewart Hotston, Vice President, Europe Starwood Capital Group
- Nicholas Lawson, Director, ING Wholesale Banking, Real Estate Finance
- Russell Gould, Director, Commercial Real Estate Finance EMEA (Citi CREF)
- Ciaran Singh, Principal, DRC Capital
The general feeling amongst those present was that post-Brexit market sentiment has improved and that the road ahead looks relatively steady albeit with some bumps likely along the way.
More details about what was discussed at the seminar are summarised below.
New developments on LMA documentation in the real estate finance market:
- New intercreditor agreement for REF transactions (providing for contractual subordination). Intended to be used for mid-market deals with senior and mezzanine debt;
- LMA note on implications of Brexit on LMA documentation;
- Recommended form of bail-in clause (dealing with Article 55 of the EU Directive 2014/59);
- Updates to REF Facility for investment grade transactions dealing with (i) debt purchase transactions, (ii) carve-outs for “Perfection Requirements” and “Legal Reservations”, (iii) additional property undertakings dealing with provisions relating to the Asset Manager, (iv) deletion of historical interest cover drawstop.
Post-Brexit indications are that market sentiment has improved:
- Panel members talked more of a pre-Brexit slowdown and noted that there is lots of capital available that has to go somewhere in the low interest environment;
- Investors are slowly re-entering the market;
- Clearly lots of uncertainty still however;
- Brexit is increasingly used as an excuse not to do deals with a poor yield rather than anything else;
- Plenty of refinancing opportunities in Europe;
- Example given of how British Land sold Debenhams at pre-Brexit price indicating prices have not destabilised massively.
Attractive sectors and outlook across the market:
- Deals with long-dated income are proving the most popular at the moment;
- Investment volumes are down (mismatch between seller expectations and what investors will pay);
- The ING panel representative mentioned that there is a flight to quality – the London market continues to perform well, as will prime / retail shopping centres in attractive strong regional centres such as Manchester etc;
- Overseas there will be lots of Non Performing Loans in Spain and Italy opening up potential value opportunities;
- UK still seen as a safe haven for real estate investors. There may be some challenges (e.g. passporting issues in light of Brexit) but other countries have major events upcoming themselves;
- The drop in the value of sterling presents some challenges. It’s good for long-term investment. In the short-term, investors can get in cheaply but they need to be able to do the same on exit;
- The reduction in the base rate has had no real impact;
- The availability of lower swap rates means it is a good time for borrowers to lock-in rates for the long-term giving more cash in the deal.
Valuations and covenants:
- General feeling that lenders were not being lapse pre-Brexit when it came to valuations;
- Post-Brexit covenants are reasonably tight but they have not tightened by much;
- Panel representative gave example that an Loan To Value (“LTV”) covenant pre-Brexit that was say 60% LTV may now be 55% and that an LTV covenant pre-Brexit that was say 55% LTV may now be 50%, i.e. small drop only;
- Panel representatives were asked whether they had seen many examples of valuers including Brexit caveats in their valuations. Representatives said these were occasionally included where there were a lack of demonstrable “comps” and even where included they were not so severe as to discourage a bank from lending. Any such Brexit caveats were frequently becoming yesterday’s issue;
- The general mood was that it was hard to tell if debt service covenants were tightening generally – the industry does not have a commoditised product, no one-size-fits-all so it was hard to judge.
Other matters discussed:
- Use of market flex rights in Real Estate Finance (“REF”) documentation - noted that this was very uncommon 2 years ago but has become more of a feature recently but is no means standard;
- Increase in non-bank lending in REF space – noted that there were more challengers in the market due to regulatory constraints on banks;
- LMA REF documentation and Brexit implications – noted that the impact of Brexit on LMA documentation was very small;
- Use of LMA bail-in clauses on deals – generally view that the recommended form of bail-in clause was being used on most deals and people are getting more comfortable with its inclusion. However very little to suggest that people are going back to old deals with a view to incorporating it;
- Green lending scheme – banks are giving borrowers a financial incentive in their products where borrowers meet green or sustainability targets. How banks do this differs very much from one institution to another. This is something that has been done in the Project Finance market for some time but now banks such as Lloyds, ING and others are really embracing this theme;
- Increasing use of amortisation schedules in loans – now easier for banks to get. A 5-year loan pre-Brexit would likely now be a 3-year loan with 2 extension options.
Impact of Brexit on development real estate finance market:
- A definite slowdown here, this being the most risky type of real estate financing with the most to lose;
- Banks less keen on this market generally and there has been some movement in margins;
- That said, demand for development financing remains strong with supply so short.
Summary – where will the REF market be 12 months from now:
- Still working through the implications of Brexit, but also dealing with other challenges such as the US, Dutch, German and French forthcoming elections;
- The market will likely remain reasonably stable if even slightly more positive – London and prime regional hotspots will likely hold up well;
- There will remain some uncertainties, for example around the UK’s use of Article 50 and whether the UK leaves the EEA etc;
- However there is no dearth in capital;
- Overall, a steady but slightly bumpy road ahead.