2023 – a tricky year ahead, but is it all doom and gloom?

An economically challenging year lies ahead, but the Real Estate Finance Market is resilient enough to weather the storm, says Fieldfisher partner Iain Thomas.

A lot had been speculated in the last few weeks of 2022 about the effect that rising interest rates and inflationary pressures were having and will continue to have on the Real Estate Finance market.
 
Here at Fieldfisher we have acted for a broad range of lenders across a wide spread asset classes over the years, so have an excellent general view of the REF market. 
 
In the final weeks of last year we saw a drop off in new lending activity from life funds and insurers who lend by reference to gilt rates.  A "wait and see" approach from those lenders was adopted for the remainder of 2022 and medium term strategies are likely to be reassessed in Q1 of this year.
 
Market correction on the cards
 
A rise in yields in certain sectors (particularly logistics) saw a slowdown of deals in the investment space while loan terms were reassessed to reflect a correction in market values.  Demand for the product remains strong but the higher pricing of debt has made the spread between the cost of funds and the investment yields less attractive. 
 
An overdue correction in the market is happening and once it has stabilised and pricing has been adjusted to match, volumes will steadily return.
 
Notably, we have seen a marked uptick in instructions from lenders who have financed developments which have hit the double headwind of increased costs of material and labour alongside a dip in demand for the completed product, particularly in the residential sector while mortgage rates (particularly fixed rates) for buyers of the completed units continue to fluctuate. 
 
Facilities are being amended to push out repayment dates and release or inject cash from other sources to fund cost overruns and get part completed schemes over the line.  Lenders are also working with borrowers to restructure the underlying procurement of schemes where contractors or other members of the professional team have become insolvent mid-development. 
 
We expect to see an increase in these instructions in Q1 this year particularly if inclement winter weather causes further delays to practical completion dates.
 
2008 all over again?
 
So, challenging times lie ahead it seems. But the Real Estate Finance market is resilient and has levers which it can pull to ensure that any storms are weathered. 
 
What is definitely not happening is something that I heard mentioned a few times towards the end of last year, namely that the market is facing a crisis on the same scale as was experienced in 2008. 
 
It is nothing like 2008. 
 
That was Armageddon - a collapse of the entire global banking system and the Real Estate Finance market did not properly recover for a good 6 years.  What we're seeing this time is a market correction while stock is taken of a rise in interest rates and inflation caused by the Ukraine war.  There is a big difference. 
 
The lessons learned from 2008 and the protections put in place as a consequence should hopefully mean that those events will never be repeated.  There will undoubtedly be pain experienced by lenders, particularly in parts of the private debt fund sector where the risks reflected in the higher priced debt offered are likely to crystallise sooner than in other sectors and are likely to be more difficult to restructure as a consequence.
 
Another important difference between then and now is the amount of equity available to deploy (directly or indirectly) in Real Estate.  Out of adversity comes opportunity and with LTVs still relatively modest compared to pre-GFC, exits are available through consensual sales to opportunistic purchasers of stressed or distressed assets.
 
Activity levels will rise
 
We have been blessed with a prolonged period of stability and prosperity led by a low interest rate environment and a stable economy.  We now have to deal with a few challenges in the year ahead, but nothing that the market has not had to deal with in the past and nothing which it has not got the capacity and resources to confront and conquer this time around.  The markets have not yet properly woken up from a holiday season prolonged by the weather and train strikes but when it does, we expect to see activity levels tick back up again.
 
In times when fees are tight it generally falls on the Lender's advisers to navigate the way through issues presented by their borrowers.  Fast and pragmatic advice based on experience in similar situations in the past is required and we feel at Fieldfisher that our team is ideally placed to lend that type of support.