Lenders congregating at last week’s annual Mipim real estate conference in Cannes were cautiously optimistic, buoyed by borrowers’ ability and willingness to recapitalise existing financing deals and hopeful that more compelling opportunities will emerge in the second half of the year.

While the consensus for current market conditions was considered “sluggish", most lenders – and investors – are already starting to look past the current malaise. There is an expectation that risk factors will start to diminish, valuations will find a bottom across major asset classes, and international capital will return in greater volumes looking to deploy across equity and debt.

In this article, we share the key takeaways gleaned from traversing La Croisette promenade last week.

The lending market remains polarised, with some lenders remaining selective on new financings whilst concentrating on consensual restructuring and refinancing on their existing books, with others actively looking for new originations. On new deals, some lenders are inactive due to pricing and risk appetite, whilst others are focusing on prime assets.

In the UK, while there are pockets of stress in markets, the relationship between lenders and sponsors remains largely consensual and few lenders are experiencing significant or widespread distressed situations. In large part, this is due to the lenders’ proactive approach over the last 12 to 18 months, consensually resolving potential covenant breaches with borrowers. We spoke with a number of lenders who have reported a consistent willingness among sponsors to de-leverage, cure defaults, agree to restructuring modifications and additional reporting and regulatory amendments, where requested. In mainland Europe the position is not quite as rosy, and Germany in particular is experiencing increased levels of stress and distress.

Non-bank lenders continue to be busy with proactive loan book management. Consensual sponsor deleveraging shows an underlying financial strength among investors, and awareness that it is far better to resolve stress, than do nothing and risk distress. It also shows the benefit of strong sponsor-lender relationships and suggests a mutual confidence in underlying market fundamentals (for example, strong occupancy trends, rental growth and the prospect of gradual monetary policy easing in the second half).

Broadly speaking, the larger lenders’ loan books have performed better over the past 12-18 months, driven by the quality of stock and sponsors these lenders have been able to attract. Some of the smaller lenders have struggled a little as they have been financing lower quality stock that have seen greater valuation corrections. It is these lenders that have been greater battle-tested, although most have weathered the storm to date, as the consensual restructuring trend shows.

For lenders that operate with back leverage, proactive problem-solving is a prudent approach. In the event of a sponsor covenant breach or default, the underlying lender must report the event to the back leverage loan provider and seek their approval on restructuring agreement with their underlying borrower.

It is far better to seek approval from back leverage providers before a covenant breach takes place than after the event, which is another reason why so many back leverage financed lenders are so proactive. More UK banks are starting to enter the warehouse/repo loan market, motivated by attractive regulatory capital treatment.

Deal flow in investment markets is expected to remain low throughout the first half of the year, with a string of macro, political and geopolitical uncertainties impacting confidence. Investors at Mipim consistently referenced two investment themes: prime technology-enabled logistics and warehouses and sustainability and social impact-driven residential in major European cities. The commonality between these themes is the bifurcation within each asset class: best-in-class and everything else.

Investor demand for modern logistics facilities and warehouses continue to outpace supply, driven by the e-commerce growth trajectory, occupier pressure to improve operational efficiency, data centre demand to support growing artificial intelligence services, and sustainability drivers, led by the electrification of truck fleets.

Rising online demand necessitates higher operational efficiency within logistics facilities to maintain margins. Increased operational efficiency requires technical building upgrades which older warehouses are often unable to accommodate, funnelling occupier demand into a narrow "best-in-class" modern logistics segment.

It is the same story as in the office sector: occupiers are chasing the top-tier advanced stock. In logistics, advanced manufacturing and distribution facilities require technical building specifications to support the machinery and equipment that operate robotics and automation processes and systems. These facilities are also highly energy intensive.

Increasingly, modern logistics facilities include solar-panelled roofs, on-site battery storage and EV charging stations, with the ability for surplus power to be sold back to the local power grid, creating a new income stream for owners, supporting higher asset valuations. Investors and lenders we spoke with at Mipim said they expect to target this "best-in-class" logistics segment in the quarters ahead as well as data centres.

Among real estate investors, data centres are considered a proxy play on the AI trend.

In the residential sector, investors and lenders both continue to see opportunity from the UK and Europe’s housing shortage. The supply-demand mismatch has worsened in recent years due to the development hiatus during the pandemic followed by supply chain disruptions which prevented scheme completions and rising interest rates making construction too expensive. As a result, residential demand and rental growth remain strong, including for private residential stock and purpose-built student accommodation. Increasingly, institutional capital is attracted to residential because it is both supported by long-term megatrends (demographics, technology and sustainability), and creates social value.

Modern residential developments can create social value in several ways by creating affordable housing, replacing obsolete legacy housing, improving residents’ daily lives with homes focused on well-being, green spaces and convenient services, and contributing to a broader urban regeneration. For investors and lenders, such residential deals align portfolio diversification with internal ESG objectives, which itself is an increased driver of capital allocation decisions. In particular, investors at Mipim cited PBSA opportunities in the UK and PRS across major cities UK and Europe-wide. Current elevated interest rates are keeping the younger generation renting for longer, supporting high occupancy rates and low tenant turnover, while income growth typically tracks inflation.

Finally, and perhaps most interestingly, another asset class that was discussed with much vigour, and often with differing opinions, was the prime Central London office sector.

Some investors we spoke to in Cannes offered the opinion that the prime London office market is relatively close to the bottom of the valuation cycle.

Some investors are willing to consider the sector, however, they are only interested in best in class Grade A offices in prime locations. In recent years, sustainability expectations and technology trends have redefined the benchmark for top-tier offices, changing investor, occupier and lender expectations. Today, Grade A offices implies an energy-efficient and amenity-focused building designed to the highest sustainability standards with technology-enabled services that promote well-being, productivity and flexible working. This top tier has performed well in the context of hybrid working trends, with robust occupancy levels and investor demand. Lenders are willing to competitively lend against such stock. Conversely, sub–Grade A offices continue to struggle, reflecting the bifurcation market trend, which extends to the major real estate asset classes and spills over into how lenders evaluate financing deals.

Investors and lenders are all chasing deals to invest into that narrow Grade A segment, leaving a huge overhang of sub–grade A stock that needs targeted capex to revitalise. Sub-grade A stock commands much lower investment demand, costs more to finance and will require significant capex budget to modernise or reposition. There currently remains little appetite for reposition plays, but we expect that it will not be long, maybe two to three quarters, before investors start to see opportunities in asset management intensive or transitional property deals. Investors recognise these are highly specialist strategies, which in the current high interest rate environment represents a challenging risk-reward return, particularly given skilled labour shortages and expensive building materials. Similar challenges are also evident in logistics. The longer-term risks for lower-graded stock are dwindling valuations and occupier demand over time, and rising obsolescence, or worse still, a new wave of stranded assets.

International capital flows were also discussed on La Croisette. Far Eastern debt investors are increasingly active as participants in UK real estate finance syndication deals, led by a relative value assessment of UK credit, compared with home markets. Separately, Middle Eastern investors are starting to look for new opportunities across prime European real estate equity deals.

In summary, the prevailing sentiment in Cannes was one of measured optimism, albeit tempered by caution. The critical question is whether this improved sentiment will translate to a rise in transactional volumes in 2024 or whether deal flow will remain limited? Whatever happens, there are lenders who have capital to deploy for the right opportunities, which should be viewed positively.

Dean Harris, Trimont, executive managing director, EMEA