Sitting in Heathrow Airport on a Friday afternoon in late February, the message was clear; no matter what way you look at it, we are late cycle. I was enjoying a quick lesson on the property market from one Ireland’s most astute and credible investors. The only bit that wasn’t mentioned was that it would be Covid-19 that would grind our economy to a halt.
Clarity of thinking is so important to making good choices, and in turbulent times like these, everyone is searching for a trusted opinion, and more importantly evidential points to support or challenge those choices. That search for clarity is common among clients in the real estate debt and equity markets at present.
Covid-19 initiated one of the fastest sell-offs in recent history with the European indices declining by around 30 per cent in 33 days. The decline in equity prices has been unprecedented both in its speed and in the volatility of movements. Governments in Europe and the US have responded quickly with support focused on maintaining liquidity and protecting citizens from the loss of income and employment.
In Ireland, unemployment levels trebled to 16.5 per cent at the end of March including those receiving emergency Covid-19 jobless benefits. By comparison, it took more than four years for the series to climb to 16 per cent in 2012, highlighting the devastating pace and impact of the coronavirus.
The true effect of Covid-19 is still unknown but what has become very obvious is that liquidity is a primary focus for both debt and equity investors. Whether the focus has been on rent collections for landlords across every asset class, interest payment dates from a lender perspective, or indeed new opportunities, the quality of the underlying income that the asset is producing is critical as investors focus on liquidity.
The Debt Market
We have seen a number of deals complete over the last few weeks which were very much progressed. The primary focus for lenders now however is internal rather than building their pipeline. Unlike 2008 where the Irish market in the main was banked locally by a handful of balance sheet banks, the spread of lender type today is diverse with large international investment banks and numerous alternative lenders among the institutions that have become an established source of leverage in the Irish market. There are some new pockets of money seeking to take advantage of the current liquidity gap but they are typically opportunistic, seeking higher than normal returns and will be cautious in their approach.
So what factors are going to give lenders the confidence to re-enter the debt market and breathe new life into the investment market?
Some of the indicators are external forces: drivers of volatility in funding costs, liquidity in CMBS (commercial mortgage-backed securities) and syndication markets, the presence of other lenders and wider market transactional activity and evidence.
Other indicators are internal to lenders and will be specific to their views and judgements and likely contingent to their existing book: they may include perceptions of future sustainable cash flow, asset class preference, risk appetite around structure and covenants, confidence in external valuations and the accurate pricing of debt to deliver an appropriate risk-adjusted return. Different lenders and groups will weight these factors differently depending on their structure and funding base, but I believe they will all feel they are issues to constantly consider.
What is clear in the current environment is that we live in hugely-uncertain times and are living through an unprecedented trigger for the issues that the lending market (and wider world) is struggling to cope with.
However, the real estate market is and always has been cyclical – and has demonstrated its resilience and agility in reinventing itself so many times over the decades. It will again. I look forward with cautious confidence because I believe that the steps that lenders and regulators took in the aftermath of the global financial crisis have helped foster a lending market that remains well capitalised and funded and can return quickly. The important factors identified above will slowly but surely be overcome, and lenders will use their judgement and risk appetite to time their return.
In the first instance, liquidity will return for core assets that are income producing supported by strong covenants. Cashflow is king in these uncertain times.
Andy Tallon is an executive director at CBRE’s Ireland & UK corporate finance division
