Margin pressure, risk provisioning and increased reports of "presumed overvaluations" currently describe the commercial real estate markets. The messages that financing institutions in Europe are currently sending out with regard to the real estate markets are complex. As a result, the effects of the Covid-19 pandemic, including lockdown and market volatility, are also being felt in the European commercial real estate markets. These put companies across the board under increasing financial pressure.
Risks to CRE lenders, regarding credit quality, bankruptcies and default rates are rising, while Euro area banks have tightened their credit standards in the third quarter. So far, however, comprehensive government stimulus packages and central bank measures have mitigated the risks to a certain extent.
The ECB will meet on December 10, the FED on December 16 and the BoE on December 17. We expect the ECB to expand its liquidity measures (PEPP/TLTRO) by duration and volume to counteract a potential further tightening in bank credit standards and to remain favourable financing conditions. Therefore, the expansion of the -1% discount period for TLTROs and new asset purchases under PEPP are most likely.
- Non-performing loans (NPLs) are expected to increase in 2020/21, but banks have significantly improved their asset quality, built up larger capital buffers and strengthened their liquidity positions while the volume has decreased significantly.
- Real estate financing sentiment recovered from the worst shock in the second quarter as the expectations of the availability of real estate financing and loan margins collapsed to record negative levels.
- Higher risk provisioning and interest margins by real estate financiers and banks lead to lower LTCs and LTVs.
- Financing terms for core buildings seem stable now, standing around 20 bps above the pre-Covid-19 level, after having risen by around 40-100 bps in the second quarter.
- Capital costs for opportunistic properties and developments have increased much more strongly.
- Margins and financing terms jumped significantly in the second quarter, partly driven by increased liquidity costs.
- Overall, we see longer financing periods for project developments than before the crisis.
- Second Covid-19-wave without market volatility: bond spreads show no signs of stress.
- German banks are holding above-average volumes of CRE loans, but at a better asset quality compared to the European average (NPL ratio at 1.7% vs. 8.1%).
- CRE default risks: Most vulnerable sectors are hotel and non-food retail, due to the coronavirus-related lockdown whereas residential real estate has shown stronger resilience.
- Mezzanine and private debt – market for subordinated financing is growing in Germany.
The next few months will certainly not be any less worried about the overall economic situation. However, the reasons given above clearly indicate that capital flows will continue to be directed into real estate investments. Especially because we expect an increased allocation volume in the real estate sector in 2021. Not even a virus stands in the way of this.