European Glide Path Report

CRE Credit & Debt Markets

What does all this mean for CRE yields? What needs to happen to allow the debt markets to free up? 

Our view: 

• Credit liquidity among banks will remain tight through the downturn until downside risks moderate (pencil in gradual thawing in H1 2024). 
• Banks are an important lender for CRE, and their diminished presence in CRE lending space will lead to a gap that other sources will continue to seek to partially fill (will be tough for these sources to fully offset the liquidity provided by banks).  
• Lending conditions and terms are increasingly onerous; more liquidity is available for best-in-class assets and preferred sectors.  
• Maturing debt is facing a particularly difficult environment. There will be more distress in upcoming quarters and years, particularly in the office sector. 
• This is not the Great Financial Crisis all over again. Banks are well-capitalised as evidenced by the European Banking Authority’s latest EU-wide stress test. Office/CRE poses minimal risk to the banking system. 

>> Read more in the full report

CRE Credit Flows & Outlook

Glide path to CRE credit flows and the outlook on property values. When will deal volume pick up?  How far will property values fall?   

Our view: 

• Our framework for the capital markets recovery is as follows:  
  • Phase 1: A slowdown not necessarily a recession – needed to bring inflation down 
  • Phase 2: The ECB and BoE pivot and start cutting rates (but not going back to zero-bound)   
  • Phase 3: Price discovery – the market reprices to the higher rate environment    
• The crux of the value story continues to be linked to comparative yields and spreads. Interest rates will remain higher for longer, meaning that property yields must adjust upward to maintain a spread relative to risk-free and other risk-adjacent yields. Accordingly, we forecast further yield expansion through H1 2024 with variation across sectors and markets.  
• Property values will decline in the 20% to 35% range peak-to-trough, with significant variation depending on property type, quality and geography.  

>> Read more in the full report

Strategic & Tactical Considerations

How should I think about the buy/sell/hold prospects right now? How do CRE returns perform historically through a downturn? What higher-level strategies are most appealing right now? What about more defensive strategies?  

Our view: 

• CRE stacks up well against other asset classes on a cumulative-forward looking basis.  
• Periods following times of dislocation are typically great vintage years for investment. 
• Income resilience remains key to the next chapter; NOI growth will remain resilient for most property types. 
• Income resilience is being redefined across each CRE property type, as well as against the context of tenants, even down to tenants’ industry characteristics. 
• Defensive/core, value add/opportunistic and debt market strategies span a wide spectrum of sectors and profiles—outlined further within the report.  

>> Read more in the full report

Value-Add Opportunistic 

• Reshaping and repurposing well-located urban assets, with a strong focus on raising their ESG credentials.  
• Focus on repurposing space for alternative uses led by life science, self-storage and healthcare as well as mixed-uses. 
• Develop prime logistics in robust corridors proximate to areas of strong demographics. 
• Well-let in and out of town retail at distressed pricing that offers income, yield and rent upside and an opportunity to bank land in highly accessible locations. 
• Develop sustainable, high-quality, flexible, office in supply-constrained, proven and resilient locations that support modern and hybrid working. 
• Well-located robust office buildings at a discount to replacement cost with active management and strategic capital investment potential.  
• Hospitality future-proofing/repositioning plays across all market segments and quality levels in both gateway cities and resorts. 
• Develop vertically-integrated operational platforms in growth sectors increasingly popular with institutional buyers (living, self-storage, life sciences) to provide a future exit and/or portfolio premium. 
• Opportunity to buy or JV medium-sized platforms due to the more restricted fundraising and debt financing markets.  

Debt Market Strategies 

• Senior debt in liquid markets offering strong core returns. 
• Given constrained liquidity for conventional financing, provide hybrid, subordinate capital in the form of preferred equity or mezzanine debt for maturing loans that need infusions of capital. 
• Longer-term durations are more appealing to lenders today and loan size is less of an issue than previously, albeit frequently using syndication.  
• For lenders, focus on those sectors with a large funding gap to secure above average returns often with controlled risks, e.g. through low LTVs. 
• Provide bridge loan financing to high-quality assets and development projects in preferred sectors such as multifamily and industrial.  
• JV opportunities to invest equity or structured debt as refinancings fall due with assets with upside and owners not looking for a short-term sale. 
• Acquire distressed debt portfolios to actively manage, break-up and refinance in due course.