Europe is bracing for a sharp and sudden real estate reversal

(Bloomberg) – The turmoil at prestigious properties in London and Frankfurt offers a glimpse of the damage that awaits European property investors as they face a reversal. strongest in history.

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From the difficult refinancing process of an office building in the City of London to the sale of Commerzbank Tower in Germany’s financial hub, investors are scrambling to find ways to bridge the financing gap. especially when the lending market is active due to the rapid increase in interest rates.

The reality check will start happening in the next few weeks as lenders across Europe receive the results of their year-end reviews. The dramatic drop in valuations threatens to lead to breach of lending covenants, triggering emergency funding measures ranging from forced sales to injection of new cash.

Skardon Baker, a partner at private equity firm Apollo Global Management, said: “Europe is going through a period of great relaxation after 10 years of easy money. “The extent of the pain and dislocation is out of range.”

Read more: The global real estate market faces a debt spiral of $175 billion

Loans, bonds and other liabilities totaling around 1.9 trillion euros ($2.1 trillion) – roughly the size of the Italian economy – are secured by commercial assets or extended to homeowners in Europe and the UK, according to a Bayes School of Business European Banking Authority survey and data compiled by Bloomberg.

About 20% of that, or about 390 billion euros, is due this year, and the impending crisis marks the first real test of regulations designed after the financial crisis. global government to prevent real estate lending risks. Those rules can ultimately make for a steeper and more abrupt correction.

“I think the revaluation is going to happen faster than before,” said John O’Driscoll, head of real-asset trading at the investment management unit of French insurer Axa SA. this. “People started showing up as the tide receded.”

Europe’s lenders will be spurred by new rules to act more aggressively on bad loans. They are also in better shape than the last real estate crisis was more than a decade ago, so may be less inclined to allow problems to worsen. That puts the burden on the borrower.

In the aftermath of the 2008 financial crisis, most banks were reluctant to collect bad debts because doing so would lead to large losses – a method dubbed “expanding and falsifying”. pretend”. Under the new rules on bad loans, lenders will have to provision for expected losses, rather than accrual. That means they have less incentive to sit idly by and expect asset values ​​to recover.

So far, valuations haven’t dropped enough to bring senior debt – loans typically held by banks – underwater, but that could soon change. UK commercial property owned by CBRE Group Inc. Valuations fell 13% last year. The decline accelerated in the second half, with the brokerage recording a 3% drop in December alone. Analysts at Goldman Sachs Group Inc. predicted that the total reduction could be as high as 20%.

Banks can then act before prices fall further and risk credit losses, forcing indebted homeowners to make tough alternatives. Problems become more difficult for those facing maturing debts. Lenders are reducing the value of properties they are willing to lend. That means a lower rating can act as a double hit, increasing the funding gap.

Vincent Nobel, head of asset-based lending at Federed Hermes Inc. Solving a problem is making it someone else’s problem.”

So far, Sweden has remained the epicenter of the crisis, with house prices expected to fall 20% from their peak. The country’s listed property companies have lost 30% of their value in the past 12 months, and Sweden’s central bank and the Financial Supervisory Authority have repeatedly warned of the risks stemming from property debt. commercial product.

Falling property values ​​could cause a “domino effect,” as demand for more collateral could force a sell-off, according to Anders Kvist, a senior adviser to the director of the FSA.

While there are some stable places such as in Italy and Spain, which have been hit harder by the global financial crisis, the UK is in recession and there are signs that Germany could be the country. next.

On the plus side, there are more options available to in-demand real estate investors. Entities such as closed-end trusts have expanded steadily over the past decade. In general, insurers and other alternative lenders had higher rates of new property loans in the UK than the country’s major banks in the first half of last year, according to a Bayes survey.

Cantor Fitzgerald CEO Howard Lutnick said during the World Economic Forum in Davos last week that over the next 18 months, investors will pour a record amount of money into so-called opportunity funds. This trend will help drive the recovery of the commercial property market, he said.

These new tools could make turmoil happen in less time than in the past when banks held on to bad loans for years. Louis Landeman, a credit analyst at Danske Bank in Stockholm, expects the reset to be relatively orderly with borrowers having enough funds to take countermeasures.

“Anyone who can think of a creative way to fill that void is going to have a great time,” said Mat Oakley, head of commercial research at Savills.

–With support from Anton Wilen, Antonio Vanuzzo, Damian Shepherd and Konrad Krasuski.

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