CB Richard Ellis Expects Orderly but Extended Work Out of the c.€200bn of European Commercial Real Estate Loans Most At Risk

According to CB Richard Ellis’ (CBRE) European Commercial Real Estate Debt ViewPoint, issued today, €970 billion of European commercial real estate debt was outstanding at the end of 2009. Mirroring their typical share of European commercial real estate investment activity, Germany and the UK account for over half of the €970 billion total, with 24 per cent and 34 per cent respectively.

Commercial real estate (CRE) lending has seen very strong growth over the last decade, and has risen faster than overall lending. This increase was fuelled by the boom period in the CRE market – both in terms of investment activity and capital value growth, particularly in 2006-2007 just before the credit crunch hit.

This triggered an upward spiral, as easy availability of cheap debt encouraged real estate investors to follow ever more aggressive borrowing strategies. In turn, this allowed them to pay higher prices, driving European CRE values to historic highs.

“The CB Richard Ellis European CRE Debt Model estimates that there was around €970 billion of European CRE debt outstanding at the end of 2009. This is roughly ten times the Hungarian annual GDP.” – commented Gábor Borbély, Senior Analyst at CBRE Budapest.

The UK and Germany account for well over half of this total, mirroring their typical share of European CRE investment activity. Further analysis shows that there are other characteristics that distinguish these two markets from the rest of Europe.

Almost €1 trillion of CRE debt is clearly a very large legacy to manage and refinance – tasks that lenders (and many European governments) will be trying to tackle over much of the next decade. A large proportion of the debt that was due to mature in late 2008 and 2009 has been rolled over or extended for a further couple of years. This ‘extension’ policy has worked so far in preventing immediate defaults, although it is starting to show through in the build-up of short-term maturities. In fact, almost half of the total European debt outstanding is due to mature over the three years to the end of 2012 – averaging €155 billion per annum. The refinancing risk represented by these looming debt maturities therefore requires immediate attention.

In many ways Europe’s commercial mortgage-backed securities (CMBS) market is a microcosm of the entire European real estate debt sector, only more so. Over 60% of the CMBS ever issued against European property (nearly $200 billion) was issued during the 2005-2007 period, the peak of the market in value terms. It is also true to say that, although the circumstances vary between individual loans, the majority of this was issued at higher than average LTVs and on poorer than average quality real estate.

In the investment market, the 2005-2007 boom drew a lot of ‘poorer’ property into the market that would not have been in the investment universe in earlier years. This is particularly true in Germany, which saw rapid growth in investment turnover, from less than €20 billion a year at the beginning of the decade to over €50 billion a year in 2006-2007.

In the light of a relatively weak demand profile, occupation will tend to concentrate in newer space, with vacancy rates continuing to grow in poorer buildings. At the same time, a lack of new development starts since early 2007 – particularly in the office sector, but also for retail space – means that there will be a shortage of new accommodation. The rental value of prime, new space is therefore likely to be increasing at the same time as secondary rents are being driven down by a continuing oversupply. Looking ahead to the next few years a trend that looks to be of particular importance to the holders of existing debt is the further divergence in the performance of prime property relative to secondary.