Insight / 07 August 2020
Long-term assessment of real estate landscape is vital
The fundamentals of UK real estate investment remain strong, but the full impact of the coronavirus pandemic on the sector is yet to be realised.
Those were amongst the key discussion points in a webinar hosted last week by AREF, Carey Olsen and Crestbridge looking at the implications on financing real estate holding structures in a post-Covid world.
Exploring the major and emerging trends in the sector, panelists Simon Todd (Group Head of Real Estate Services at Crestbridge), Peter German (Partner at Carey Olsen), Daniyal Ansari (Real Estate Finance Partner at Bryan Cave Leighton Paisner LLP), and Dean Hodcroft (Chief Financial Officer at Cale Street Partners) told moderator Stephanie Workman (Senior Manager at Crestbridge) that whilst they had seen some evidence of professional landlords being impacted by tenants experiencing cashflow problems, they hadn’t seen any major restructuring - yet.
“The common process so far has been in getting set up to deal with assets remotely, managing cashflow and managing lending,” commented Simon. “We haven’t seen any major restructuring as yet, but we have been enormously busy on the debt fund side in terms of volume of transactions.”
This was echoed by Dean, who highlighted that the period has been typified by looking intensely at legal documents to understand exact positions.
“We’ve seen a mix of formal and informal waivers to help get through the early stages of all this,” he said. “Overall, it’s been a period of forbearance.”
This sentiment was reinforced through an audience poll during the discussion, which highlighted that two-thirds hadn’t experienced any problems in raising finance since the start of the crisis.
However, panelists were quick to highlight that the sector is only in the early stages of a long-term much more challenging environment.
“It’s probably too early for war stories,” explained Peter. “In Jersey, the law has afforded some welcome flexibility to directors of companies when considering the onset of liability for 'wrongful trading': directors must take ‘reasonable steps’ with a view to minimizing the risk of potential loss to creditors; whereas the English test requires directors to take 'every step' toward the same end – but we’re moving on now from the initial stages of immediate issues around default and we’re starting to have conversations around restructuring. What’s clear though is that there is a long way to go until we see the real fallout.”
Panelists agreed that some significant change was inevitable over the coming months across sectors and in terms of underwriting, and that major defaults and bankruptcies were likely.
“Changes to underwriting were already underway before the crisis,” said Dean. “But more is now undoubtedly on the way. The default now will be to look at the worst-case scenarios, and there are real differences across the different sectors.
“The office space, for instance, is very interesting in the context of remote working and there are conflicting outlooks but it looks like something will have to give. There is also extreme caution in the retail sector. However, the residential side is positive, and in the student accommodation sector demand is still very high in the UK. The picture is very nuanced.”
This was echoed by Daniyal, who commented that Covid had further exposed weaknesses in certain sectors.
“Over the past few months, we have seen retailers increasing their online presence in response to the pandemic. That was happening anyway, but Covid has acted as a catalyst to the pace of change. There are clear and real ramifications for real estate investment.”
Peter added that the new environment had turned some economic principles on their head.
“In the past, in terms of retail, for example, high footfall would have been a major positive. Now we are looking at things through a new lens, where human density might be seen more as a potential weakness and as a result, conventional business plans may need to be reevaluated.”
This was reflected in a further audience poll during the discussion, in which 75% indicated that they thought Covid-19’s impact on debt availability, pricing and structuring would have an impact on investment strategy, with the same proportion also feeling that lenders’ fundamental underwriting principles would change as a consequence of the crisis.
Considering how the current crisis compared to the global financial crisis of 2007/8, panelists were pragmatic.
“There are differences,” said Simon. “The impact this time is truly global and we are likely to see more big defaults as corporates have really leveraged up. What we have seen so far, though, is that the banks have learned from their past experiences, are generally now in better shape and have acted commercially.
“Interestingly, according to Preqin figures, there is still around $85bn of dry powder in the European private debt space waiting to be deployed, so this time there is capital there. The massive question is where to put it.”
“The key difference is that the GFC underlying asset values were collapsed in a highly leveraged environment which resulted in a banking crisis and need the need to fundamental restructure balance sheets. The underlying cause of the problem here is not inflated asset values or high leverage – its borrower liquidity caused by the lockdown - if there is no rent coming in then loans will default,” added Daniyal. “At the moment, it’s a liquidity crisis but real estate loans are less levered than they were pre GFC. Ultimately, it’s difficult to compare now with the global financial crisis, because we’re right in the middle of this one. There’s a long way to go.”
Looking forward, panelists were in agreement that big changes were on the way and that investors and borrowers would need to face up to the realities of the new context, but that forward planning and seeking expert advice could help soften the blow.
“Documentation around real estate financing has generally held up well, but borrowers should take the opportunity to look at the detail around things like financial covenants and cure regimes, and we are seeing lenders asking for greater downstream credit support for extensions of credit – income guarantees are one example,” said Daniyal.
“What’s become clear,” said Dean “is that you can’t contract for every eventuality. This is still very much a relationships-based business.”
Simon agreed, adding: “We’re likely to see much greater stress testing going forward, but we’re also likely to see a greater emphasis from lenders on relationships behind the assets alone.”
With certainty and stability likely to play a key role in the coming months, Peter was positive about the role Jersey could play in supporting UK-bound investment too:
“Jersey has a good toolbox for structuring and even the enforcement option of an English law administration for a Jersey company is now regarded as a 'well-trodden path'. Over the past few months, Jersey has shown resilience as a jurisdiction and vehicles such as JPUTs and Jersey companies as UK REITs have continued to show their utility and that should resonate well with investors going forward.”
The webinar can be viewed again here.