A Closer Look at Europe’s Capital Markets
- Nov 20, 2018
In September, Bill Sexton took on the role of senior managing director of EMEA for Trimont Real Estate Advisors after five years at London-based Mount Street Loan Solutions, which he co-founded. The move backed Trimont’s commitment to aggressive growth in Europe and the Middle East. Part of Sexton’s mission will be to help drive modern solutions for globally integrated loan servicing, asset management and due diligence. In the following interview, Sexton shares his views on the European debt markets, the challenges investors face in the area and how the next downturn might play out.
The largest markets in the U.S. are facing a wave of new development. What is the general outlook in Europe and what can you tell us about financing new construction?
Sexton: It’s similar. As with most things related to commercial real estate, the European market lags the U.S. in many ways. Actually, we’re no different than the U.S., other than the fact that we’re slightly behind the curve.
Construction is increasing. Availability of debt to fund it lags slightly. When people were trying to buy leased buildings in the early days post-crash, they couldn’t find the debt. Then, they were going up the risk curve. The debt was lagging behind. It was hard to raise construction debt, particularly from banks, and it still is to a degree, largely because of regulation. Speculative development is hard to finance in the traditional European way, through a balance sheet lender. Non-bank lending is now filling the gap.
How did the lending environment change post-recession?
Sexton: In 2007, (in the United Kingdom) 95 percent of lending and debt financing in commercial real estate came from banks. Non-bank lending, as we now know it, was almost nonexistent. Just a tiny bit of CMBS. Now, 25 percent of the market is coming from insurance companies and debt funds. We’ve got international banks, German banks, U.K. banks offering debt—some of which is being held on balance sheets, some of which is being syndicated down further. The makeup of our debt stack has changed completely, giving us a much more diversified market on the debt side, gravitating towards the U.S. system.
Bank lending in 2007 was at 95 percent. In the U.S. it was 15 percent. It was almost inverted. The U.S. has much more diversified players and therefore a much more stable market. In Europe, we were totally dependent on commercial banks, and as soon as commercial banks were taken off the table, we were left with next to nothing. This void is being filled, and this shows in a much more diversified debt market.
To what extent is the debt market more diversified?
Sexton: This is an important part of where we go next and this is what most people are interested in—where you go next. When you have a more diversified debt stack, you have more resiliency and protection within the market if things start to cool down. No doubt that the diversification and the increased regulations over the past 10 years have had a material impact on the market, on the degree of leverage and affordability. Now, 78 percent of loans in the U.K. are at 60 percent or less LTV.
If it’s spec construction, it’s tricky to get bank financing, unless it’s a really blue chip, really central, CBD, global city development. From our perspective, at Trimont, we get interested when it’s non-bank lenders. Banks tend to look after their own positions. Non-bank lenders tend to use service providers like us. Trimont has construction loan finance in its DNA. We’re the largest third-party servicer of construction loans anywhere. The reason we are investing so heavily in the European platform is that as construction increases and spec construction becomes more viable on the equity side, then the debt financing, is likely to be provided by non-banks, potential clients of ours.
As it is in the U.S., dry powder is stacking up in Europe, and it cannot be deployed because of regulation and lack of product to buy. What are your thoughts on this?
Sexton: There is no doubt that there is a surplus of capital looking to access the market. Also, there is no doubt that regulation is making deployment of some of that capital tricky.
Coming back to construction. One of the alternative routes to finance construction is equity joint ventures or forward financing or forward selling—financing construction through a forward sale—because equity is looking to be put into the market. That is an overarching issue within the market—money is not the constraining factor, opportunities to deploy it is, to some degree, a constraining factor.
What about supply?
Sexton: I’ve been interested to hear what some of the investors have been saying as well, because the debate is “At what point do you flip from being a buyer to being a seller?” It’s not like buildings have just vanished. The European real estate market is pretty much the same size. The stock and the supply is there. It’s just being held.
At some point, you’re starting to see some of the traditionally shrewd, seasoned investors either bedding down their capital stack so that, if there is a correction in asset pricing, they’re probably capitalized, and they can withstand that or starting to think about disposing of less core assets, the ones that are maybe more exposed. I think there are always opportunities to deploy money. It’s just a question of whether or not you want to deploy it at that price, at that time. This doesn’t detract from the fact that there is a wall of capital out there.
One of the arguments people use against a significant market correction is the wall of equity out there that needs to be deployed. It’s a pretty strong argument because it’s true. But we’ve also seen, on a number of occasions, that the money is there one day, but it can vanish pretty quickly or the appetite to deploy can vanish pretty quickly. The market currently is capable of being supported by the amount of money that we have. The question is whether it is artificially priced as a result.
What are your expectations for 2019?
Sexton: Most businesses will be continuing as they have done in 2018, but in the back of their mind they will be preparing for the next phase of this economic cycle. People will continue to build their businesses and deploy capital, but most (C-suite professionals) that I’ve been talking to are turning at least a quarter of their mind towards ensuring that they are in a position to either benefit from or at least stay stable in any adverse conditions they might encounter in the next 24-36 months. I think there will be a bit of preparation for a correction.
Brexit, the trade wars and other geopolitical issues that we have to deal with as business people are always going to be in the back of people’s minds at the moment and the impact these factors will have at the local level. Brexit or how the Italians will take on the Europeans with their fiscal budget and what impact that has. I think the (American trade war’s) actual impact at the moment is limited.
However, the damage is the sentiment that it leaves within the market and the concern that it causes. As with everything, we don’t like uncertainty in business. If we don’t like uncertainty about what this Brexit thing means and looks like, we don’t like uncertainty about where these trade discussions or trade wars, call them what you like, are going to lead. From a wider economy, I think it’s more about where does this lead. Where does it end? What is the world going to look like?
What do you think the next downturn will look like?
Sexton: I’ve now seen I don’t know how many downturns. A lot. I’ve been doing this for 30 years. One thing that’s common about all of them is that you can never foresee the catalyst that is going to kick-start it. You never quite know what it is that is going to be the straw that breaks the camel’s back at a given moment. So, people are asking now—is it going to be rate rises? The problem with rate rises is when you come for refinancing. So, it has a lag effect. Not being able to get the debt to refinance the original loan. Fixed-rate loans are fine until you have to come off them or have to refix. These things have an impact. I don’t know what it’s going to be.
Image courtesy of Trimont Real Estate Advisors