• Real Assets
  • Real Estate
  • Global Real Estate

Overcoming underwriting obstacles in a pandemic and beyond

The near-term disruption caused by the coronavirus has been testing for real estate borrowers seeking finance and originators. Gregor Bamert explains why new deals are still possible for those able to look through short-term uncertainty.

Overcoming underwriting obstacles in a pandemic and beyond

Along with every other asset class in 2020, the real estate debt market has not been immune from the economic fallout of the coronavirus, which has presented unforeseen obstacles to underwriting.

Apart from new lending, around £43 billion worth of loans are due to be refinanced in 2020 and 20211 in what can only be classified as an opaque economic environment. The measures taken to slow the spread of the virus have had a debilitating impact on economic activity in some areas, but others have been comparatively buoyant, making conditions as difficult to understand and predict as any we have seen.

There is still considerable uncertainty around the way lockdown measures might be used to manage the spread of the virus and for how long

Meanwhile, there is still considerable uncertainty around the way lockdown measures might be used to manage the spread of the virus and for how long. Questions are also being asked about how broader structural and societal changes, like the shift to e-commerce and appetite for homeworking, might impact real estate markets. Add Brexit into the mix, and you can appreciate why the range of forecasts is wide.

In the short term, the consensus is for GDP to contract around eight per cent in the UK and euro zone in 2020 before recovery next year. The more bearish have not ruled out a decline of 11 or even 12 per cent, even with targeted fiscal and monetary support.2 Contractions of this scale will inevitably take a toll.

Looking through near-term challenges

Nevertheless, it is important to remember the current uncertainty will pass. From a lending perspective, we aim to take a more constructive view over the medium-to-long term. We expect to see a shift to a genuinely ‘new’ normal, where pharmaceutical intervention can be used to counter the spread of COVID-19 and a high degree of mobility will be possible again. Over the life of a loan that may stretch fifteen or even twenty years, this phase is likely to last longer and be more significant than the current one.

Secondly, we concentrate on gaining a granular view of the fundamentals, taking the downturns that inevitably occur across the business cycle into account.

It makes sense to address the experience of the sponsor, as they are actively committed to the assets

In our experience, it makes sense to address the experience of the sponsor, as they are actively committed to the assets, and the robustness of their business plans before moving to loan term and structure. How sponsors have managed operational decisions and adapted to the pandemic are excellent indicators of the degree to which further lending might be appropriate.

Many sponsors have been working tirelessly and proactively with tenants to ensure their portfolios are well looked after during the downturn. They have provided help when required and been transparent about how their assets are performing. These are clearly sponsors worthy of support.

Our data allows us to calibrate a sponsor’s business plans, rent collection experience and lease re-gearing and/or restructuring activity against their peers. We have seen a strong overlap between better-managed operations and those prioritising environment, social and governance considerations in their investment and operational decisions. Being able to access this information is enormously valuable in our underwriting process.

Grounding underwriting decisions as change accelerates

Strong governance is paramount now, as the market environment has led many existing trends to accelerate. With the retail environment in flux, a transformation in the way companies think about the trade-offs between office-based and remote working and a greater focus on supply chain resilience, it is vital to ensure exposure is in the right locations and businesses. It is also important to be mindful of how fast conditions can change.

Underwriting decisions must be based on detailed analysis

Underwriting decisions must be based on detailed analysis, with the specifics of each property ideally broken down to unit level. In an office property, for example, the detail extends to individual floors or even suites. Each unit is assigned a use class, a measure of quality and a tenant if it is let. We seek clarity on the nature of the tenants, their lease position and trading performance, as well as the corporate entities in the hierarchy and any guarantor arrangements in place.

Our data set is extensive, as we collect information and lend against more than 2,200 individual properties in the UK alone. By monitoring information closely, any change in usage or tenancy can be picked up at a granular level, and up-to-date credit and valuation views can be maintained. That makes it possible to quickly form a comprehensive view on risks and potential rewards if we are approached to lend against specific assets.

Altering stress scenarios to reflect COVID-19  

Modelling stress scenarios is an important part of the underwriting process, but it has been particularly difficult recently to define what appropriate stress cases might be. Some reframing has been needed, as the measures taken to check COVID-19 have led certain tenants to experience an unprecedented slump in income. Conversely, others have benefitted or been able to trade through largely unscathed.

Any immediate pressure points do not necessarily reflect a borrower’s longer-term prospects

We recognise that any immediate pressure points do not necessarily reflect a borrower’s longer-term prospects. Whether the outlook for a loan shows marked improvement or deterioration three months after funding is unlikely to be the ultimate driver of returns.

Balancing risk and reward   

Once we understand the context in the round, we can set out an appropriate loan term and structure. Clearly, this needs to reflect the differences between senior debt and equity, with protection for the senior lender from downside risk, coupled with potential for upside performance for equity holders.

LTVs have tended to be more conservative than at the time of the global financial crisis

Overall, loan-to-value ratios (LTVs) have tended to be more conservative than at the time of the global financial crisis, and lenders are mindful there may be further downside across a variety of asset classes. This is a factor we have on the radar, but we do not dwell on LTVs. Instead, we look closely at the quality and experience of the sponsors and the nature of proposed collateral to reassure ourselves. If we are uncomfortable with the risk, we will not participate at a lower LTV; we will not take part at all.    

While the environment is challenging, taking an appropriate perspective, focusing on the fundamentals and using the full depth of information available are making it possible for lenders and investors to be suitably confident in the opportunities they are pursuing in commercial real estate. To work effectively, trust is vital; well-grounded relationships make it more likely that information is shared, issues are flagged early and solutions to problems are found.

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our privacy notice.

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.