The potential for a refinancing "cliff" prompting a wave of distressed commercial real estate sales over the next year, the likelihood of banking contagion in the United States spreading to European and United Kingdom real estate, and the return of "back leverage" to boost lending returns dominated discussions at this week's Commercial Real Estate Finance Council Europe Spring Conference.

CoStar, law firm Ashurst and advisers Trimont were sponsors of the key industry meet-up for commercial real estate lending practitioners, who congregated in the City of London late last month.

The dominant topic was how banks would respond to the large amount of refinancing needed over the next year at a time when interest rates are rising and values are collapsing. The most recent Bayes Commercial Real Estate lending report found the interest-rate environment led to a very rapid increase in refinancing activity in the final quarter of last year, and borrowers refinanced early rather than waiting longer into 2023, or extending loans into 2024.

Lenders at the conference tried to quantify the scale of next year's refinancing, and discussed how they would respond to loan defaults and extension proposals.

Matthew Richardson, chief executive at Income Analytics, described the "refinancing wall" as the "next pricing discovery point" for commercial real estate and how lenders choose to deal with it is critical. "If there are a wave of distressed sales than we will face a real problem."

Rob Weinberg, co-head of European financing at Eastdil Secured, said in terms of refinancing his company was extremely busy in the UK and Europe. "There are estimates of the refinancing gap that range from €30 billion to €80 billion. Europe is predominantly a five-year floating market and base rates have increased significantly, while margins have been relatively static. Most real estate financing was accretive during the low interest rate period, but that is not the case now. While there will be refinancings agreed with sponsors agreeing to put in more equity, you will find certain instances where well known investors will not be prepared to do so. In those instances and others, there will be short sales to recover on behalf of the bank. Consensual short sales will likely be more common place as opposed to large-scale, heavily discounted [non-performing loan] trades."

Edward Daubeney, co-head of debt and structured finance international capital markets, EMEA, said JLL was extremely busy as well. "2019 was a big year for lending and a lot of that was for five years and of course there will be some loans coming up next year where the value has definitely dropped. So the question is do you sell or do you recapitalise and put more equity into deals, or will the lenders extend for a little bit? The interest rate environment is challenging and everything does take longer, but the deal volume if anything is going up. Another question is is there enough capital to fill the gap compared to for instance in 2009. There are of course a lot more alternative lenders but here it will be more expensive."

Participants said the biggest problem facing the market is a lack of transactions to confirm pricing, which is holding back valuations and lender decisions.

One leading investor who declined to be identified said: "There is not an equilibrium point just now as inflation and interest rates have risen between where buyers and sellers think values are. We need more stability and clarity on both where inflation and interest rates will land before this can happen."

Weinberg says there are deals happening, though many are off-market: "Where is the equity market? Beds, sheds and meds, or logistics, [private rented sector] and student housing and life sciences are still active sectors. Buying and selling is also in smaller ticket sizes and in emerging asset classes and operating real estate. In addition, a number of deals are being done off market."

Richardson said as the market is having to look for returns entirely from income, a range of issues need to be taken into account when investing and lending: "This is now an income-only market and an important development for valuers is that [the Royal Institution of Chartered Surveyors] is calling for a move to discounted cash flows when valuing."

Critical is understanding the income and the likely performance of the occupier, he adds.

"Really when evaluating tenant quality, the credit rating of a business is essentially a subjective and pointless piece of data. Pay attention to the failure score and focus on the probability of default, or PD, rate. Also be careful when confirming the identity of the borrower as corporate structure can be complex. Real estate now needs to improve the quality of its underwriting and risk management processes so that it can be compared more favourably with the equity and debt markets. It is also about the G in ESG, which is improving governance. Given the problem facing the property sector there is a greater need for using quantitative analysis and hard data when making investment and lending decisions."

The conference focused on businesses' strong appetite to have credit platforms as well as continued concerns over what has been happening in the US, as first Silicon Valley Bank and then the wider regional banking market hit difficulties. The question was whether this has the potential to spread stress to Europe's banks.

Weinberg said: "It is rare to have a meeting with an equity investor who says they are not interested in credit. We do have a very functioning financing market in Europe. In the US there is currently more stress, particularly with respect to office financings. Even best-in-class offices in major metropolitan US markets is a real struggle. There is certainly risk that stress could come over from the US especially as the large US banks are major lenders in Europe. I personally think lending conditions will get tighter over the year, but don’t think it is going to be the end of the world."

Richardson, said that with the smaller US regional banks what has been seen is the "age-old disconnect between mispriced property assets and the debt market".

He added: "When interest rates were low buying real estate was like shooting fish in a barrel. CRE real estate became a proxy for the bond market, and when the liquidity was taken away capital values tanked.”

JLL's Daubeney hosted a panel which focused on, among other things, returning interest in the evolving market for back leverage, which is used by debt fund managers to improve internal rates of return by securing debt at a lower cost than the equity commitments to the fund. It includes loan-on-loan financing. He said his sense was availability had improved in recent months after a decline in the final quarter of 2022.

That decline came as the interest rate rises meant it became too expensive for debt funds to use back leverage to generate returns.

Randeesh Sandhu, co-founder and CEO, Precede Capital, mentioned this return to activity after a slowdown: "We use [back leverage] to boost returns by retaining a junior piece and the type of finance available is often changing. Recently the number of participants in the market has increased again and margins have dropped."

NatWest director of real estate finance Paul Kiley confirmed the bank has a team providing back leverage.

Development finance has become more difficult to source in some markets but is still a busy area for lenders. The Bayes report for last year found development lending made up 23% of new origination in 2022, and for the first time since the pandemic started included speculative development finance.

Daubeney said development financing in the first quarter of last year had been very prevalent but with the cost rising due to interest rate increases, and some lenders being risk-off, it is trickier now and availability had declined.

Marc Eden, investment director at residential developer Regal London, said: "Development finance availability has been volatile over the last 18 months due to the anxiety around the exit. There is a lot of pressure on the development appraisal so sponsors need to work hard to find value."

Precede's Sandhu agreed : "Development finance is more challenging. There has been a long period of price discovery by lenders and we are constantly assessing what we believe value is in [loan to value]."

All participants see ESG and green lending as a growing and central part of the market.

Jonathan Haas, director, RBC Real Estate, said: "Regulatory changes mean ESG is a real focus for us, and this is coming from our LPs and from tenants too."

CoStar is a sponsor of the CREFC Europe conference.