Those suffering from addictions are always the last to realise that they are acting not out of rational choice bu are compelled by habit or deep-seated needs.
And so it was that the UK government brought forward its Help to Buy scheme for residential property just as the US Federal Reserve blinked while considering reducing its bond purchase programme.
No one claims to have really “fixed” the world economy with reliable post-Lehman reforms, or created truly healthy growth, and it appears that, as economic fundamentals remain fragile, the world remains hooked on debt.
The commercial real estate debt market cannot set itself apart. The speed with which the tide has come back in on available debt financing terms is alarming and is creating an environment in commercial lending, in pockets at least, that is as frothy as the Help to Buy scheme is in the residential sector.
With real estate investors living in a constrained return environment, competition for stock growing and yields falling, there is a temptation to ameliorate those returns by using ever more aggressive debt structures. This becomes dangerous only when lenders are willing to supply this instinctive demand.And once again, that seems to be the case.
The market view on the state of European lending is evolving quickly but it is clear that competition in core areas – a definition itself that is expanding – is only becoming stiffer, with ultra-high loan-to-value terms accessible once again, the cut off points for senior, “stretched senior” and mezzanine loans extending – often now under the old whole loans banner – and loan margins tightening.
Surely, as a borrower, this is good news. It means that the potential sources for debt are varied and competition is stiff, enabling us to secure better terms. It is also curmudgeonly to express dissatisfaction in the state of the debt market just when the party is getting started again. So I will concede that the current debt market is indeed far more preferable to that which we lived through over 2007-11. But I am tempted to ask, “What happens when the party ends again?” And end it most surely will, even if that end is not immediately in sight.
When it did last time, all participants in the real estate debt market suffered, irrespective of their behaviour until that point. Due to the sheer exuberance of the market up until the financial crisis, the real estate lending market virtually collapsed and debt became inaccessible to all. For many sensible borrowers as well as the worst offenders it had disastrous ramifications. Lenders and borrowers are still dealing with the default fallout that ensued and this is a situation that we must again avoid.
Now feels like a good time then, before the party really gets going again, to remind investors, borrowers and lenders of their mutual responsibility to create a sustainable debt market and not to be caught up by addictions and excesses once again, unless we are to return to the dark days sooner rather than later.
Stability is reliant on lenders keeping their heads and recalling the basic structuring lessons learned in 2007-08 that seemed so obvious and immutable at the time rather than allowing underwriting standards to creep southwards. It is also reliant on borrowers, however, to manage the temptation to take every penny available to them and to consider the payoff between basic financial terms, such as leverage and margin, with those matters that initially grab fewer headlines.
When considering what debt is appropriate, borrowers must consider their own realistic downside and seek to protect themselves accordingly by insisting on relevant covenants while fighting for terms that retain flexibility, be it financial or operational, to allow them to manage their property first and debt second, rather than the other way around.
It is only if market participants can keep this in mind, even with party “liquidity” in full flow, that we can ensure there won’t be a swift repeat of the bad times again for real estate lending.
But I can almost guarantee that many lenders and investors will need a few paracetemol, again, at the next downturn because of their over-indulged debt habit.
Colin Throssell is head of Treasury at Henderson Property
