Alternative and Project Development Financing

February 7, 2023Real Estate
Real estate leaders from the German and European markets gathered on January 26th for a GRI Club Online Meeting on the subject of Alternative and Project Development Financing. The attendees discussed a range of topics including senior, private, and mezzanine debts, allocation of capital, green financing, and much more. The region is currently facing a number of challenges, making this conference the perfect platform for top industry professionals to share market insights and strategies for the future.

Inflation and Financing

One of the big obstacles covered by the event participants was of course the continuing issue of high interest rates and insufficient price reductions, as well as the resulting impact on the viability of development financing. Capital returns are another major concern and the market has proven difficult to predict. This has led to the exploration of alternative financing options for senior debt and a general consensus that the capital market is on hold.

A key point that was discussed regarding alternative financing was recognising how the allocation of capital has changed, and that alternative investments have become less appealing compared to bonds. Our members considered that this may result in alternative lenders being more cautious and lead to a subsequent reduction in capital flowing into private debt funds. 

The decrease in insurance company investments in private debt funds is making it increasingly difficult to attract major institutional investors, while traditional banks are largely operating as usual due to being unable to reallocate capital to other industries. The distribution market is facing challenges due to pricing and lower asset valuations, especially in fixed income.

Deutsche GRI 2023

Development Dilemmas 

The attendees observed that lenders have begun to avoid new developments due to low margins and are increasingly concerned about developments that are already under way. Developers who overpaid on land for new projects are now faced with higher costs and reduced returns, with many having more than 80% debt in their projects. Risk has escalated with this loss of project equity.

On the topic of new developments versus value-add financing, the attendees discussed the fact that while 65-70% LTV (Loan-to-Value) is available for new projects outside of Germany, it is now almost expected to see 70% senior debt - with the rest funded through mezzanine financing - inside the country. The financing options available for new projects primarily depend on the location and the rental potential of the future property. 

It is thought that the future allocation of capital to mezzanine funds is likely to be dependent on their focus going forward. Our members predict that only mezzanine funds with strong credit ratings will receive capital, while those with significant political or legal risks may face issues in the coming year.

Some developers in Germany are putting projects on hold or only developing in prime locations, while others are only considering value-add financing for the biggest sponsors they have global relationships with, and will only consider top locations. Residential companies may be set to face bigger issues with financing, as low yields create difficulties in sustaining long-term financing. A stronger seller market could emerge as a result.

ESG and Equity

With regards to the ever present matter of ESG, our members noted that the push towards a green transition is leading senior lenders to focus on value-add investments. The different ESG standards for existing stock and new builds have become a factor when considering financing options, and it has been demonstrated that new builds with strong ESG foundations are better at retaining their value. Some lenders have elected to focus on financing green assets or brownfield sites that will be turned green in their development.

The financing market needs to return to normal before the equity market can recover. At present, only the limited number of companies capable of buying with 100% equity are able to participate in the market, while the lending market is waiting for transactions to resume to determine the new underwriting norms. The market is expected to be difficult before summer, and the timing of its return remains uncertain with the financing and equity markets unable to find common ground.

Although it is apparent that Germany has many hurdles to overcome in 2023, the insights gained from belonging to a powerful network of industry leaders can make the challenges significantly more manageable. To stay up to date on how Germany tackles these issues and to learn more about what lies ahead, sign up now for Deutsche GRI 2023 on May 3-4 at The Westin Grand Frankfurt in Frankfurt am Main.

Written by Rory Hickman