Iain Balkwill

The European commercial real estate lending market is about to be transformed with the arrival of collateralised loan obligations.

Since the global financial crisis, the European commercial real estate (CRE) lending market has been a story of shifting sands, with banks retreating from lending against CRE and debt funds rushing to fill the void. Nevertheless, despite this apparent shift, banks have continued to play a pivotal role by indirectly financing CRE, and providing debt to these alternate lenders in the form of loan-on-loan facilities and repo lines.

Today, the market is on the cusp of a paradigm shift, thanks to Starz Real Estate’s recent closure of Europe’s maiden CRE collateralised loan obligation (CLO), a capital markets instrument created by the securitisation of loans secured by CRE. In other words, funds raised in the capital markets will finance CRE in lieu of banks.

This product has enjoyed immense success in the US and, therefore, it was always going to be a matter of time until it made it across the Atlantic. The arrival of this product in Europe is a genuine game-changer and it is destined to play an integral role in the European CRE lending market in the years ahead.

Financing tool

Although a CRE CLO structure is versatile, its primary application is likely to act as a balance sheet financing tool for CRE lenders. The rationale for this lies in the fact that this form of financing offers attractive interest rates and advance rates; at the same time, it affords alternate lenders a decent level of flexibility on dealing with underlying collateral, while maintaining a relationship with their borrowers. Indeed, if the experience in the US is anything to go by, these structures are ideal for financing transitional CRE, which is currently in abundant supply as property owners go about the arduous process of re-positioning assets in the wake of the pandemic, but also embracing environmental, social and governance principles.

On a macro level, the arrival of CRE CLOs can be considered to be hugely welcome, given that these transactions distil risk related to CRE lending from the banking sector and transmit it across a diverse range of capital sources. A CRE CLO is also a product that brings about much-needed openness and transparency by shining a light on a traditionally opaque CRE lending market. Equally, from an investor perspective, a CRE CLO is an appetising proposition as it is not only a liquid alternative to the loan syndication market, but is also a product that has multiple additional protections when compared to commercial mortgage-backed securities (CMBS).

One of the benefits of CRE CLOs is that the CRE lending market will be less reliant on bank capital. That said, banks will continue to perform an important role in this market. Drawing on their financial expertise and deep relationships, the banking sector will play an integral role in arranging and marketing these securitisations.

Banks will also be required to deploy capital in the form of warehouse facilities to alternate lenders as they go about their business of building a portfolio of loans ready for securitisation. Accordingly, banks will assume the mantle of being the chief architects of the CRE CLO product as it grows and adapts to the European market.

Looking ahead

In terms of the future of the product, the blueprint provided by the US market is extremely compelling. In the US, the first CRE CLO came to market about 10 years ago and since then activity has skyrocketed, reaching an eye-watering $45bn of issuance in 2021. As the European structured CRE market typically lags the US by a few years, there is every possibility that Europe will follow the same trajectory. Parallels can be drawn with the arrival of CMBS 1.0 in Europe and the subsequent explosion of activity.

Given the positive fundamentals of CRE CLOs and the huge success of the asset class in the US, its arrival on European shores is an exciting development for the European CRE lending market. Against a backdrop of rising interest rates, a large number of transitional CRE assets and the incessant need for alternate CRE lenders to access cheaper forms of capital to remain competitive, tailwinds are certainly in place to spur on a significant level of growth of this new asset class in Europe.

Ultimately time will tell, but one thing that is certain is that the European CRE lending market will continue to change and the banks will continue to be fundamental in supporting its progress.

Iain Balkwill is partner of international law firm Reed Smith.


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