18 April 2023
The Changing Shape of the Lending Market
The real estate lending market remains in a challenging space as we approach the second quarter of 2023. High interest rates and political volatility have created an overall sense of uncertainty, felt by borrowers and debt providers alike.
As valuations look to fall throughout 2023, we expect a slowing in acquisition deal flow. Combined with the increased cost of borrowing through interest rate rises, there remains a high risk to lenders of breaches in loan covenants, forcing them to call in loans and enforcing sales in the worst-case scenarios.
As such, a sense of caution is generally prevalent from our lender clients, who, whilst keen to retain deal flow, are adopting a significantly more selective approach in their chosen financings to protect their long-term position. Nevertheless, the increase in alternative lenders and debt funds with greater flexibility continues to create new funding opportunities across Europe, and particularly in alternative asset classes.
With the volatility facing the lending sector over the past few weeks in particular, as a result of the ongoing banking crisis, we await to see the long term effects on European debt providers.
Trends affecting the property insurance market
Following the rate correction imposed by insurers over the last two years, after a long period of overly competitive pricing, the markets remain particularly cautious on their appetite for new risks.
When taking on new risks, insurers continue to push for in depth underwriting information around the assets (construction details, occupancy, protection measures and exposures) along with clear demonstrations of claims history, to ensure that they have a clear understanding of their exposure going ahead.
Given the constraints on capacity, most large insurance placements are seeing participation from multiple insurers, which we are seeing create challenges around policy wording agreements, due to multiple capacity providers needing to agree certain clauses.
Insurance providers remain tight on their capacity limits, and diligent around the scope of cover which they are willing to offer on assets.
How insurance market developments are likely to effect the lending space
As deal opportunities diversify, through alternative asset class investment for example, it becomes more important than ever to maintain a clear understanding of the attainable coverage in the market.
Given insurers’ approach to capacity, we expect to see these types of risks scrutinised by underwriters, adding complexity to the insurance placement process.
With increased activity across Europe, we expect to see further discussions around the cover nuances across different territories, and how these can affect lenders requirements. With variances in limits for certain types of insured peril (flood, earthquake and Stormsurge being the key drivers in certain territories), it is not always possible to ensure coverage for full reinstatement, which can affect the usual LMA insurance requirements under a Facility Agreement.
The increase to inflation (specific to reinstatement costs) will continue to be a key factor when assessing sums insured for assets. High inflation levels and increased cost of materials mean that policyholders / lenders cannot rely solely on index linking to safeguard them from underinsurance.
It will therefore be crucial to ensure that waiver of average clauses are built in to policy wordings, and that reinstatement cost assessments (RCA’s) are undertaken regularly to ensure that sums insured are kept adequate across the loan term – hence, why it is imperative to review insurance policies on an annual basis as existing loans mature.
As we see lenders increase their activity in development loans, it remains important to ensure that insurance requirements are tailored to deal exposure, with clarity provided where there are multiple loan phases so that insurance policies can effectively transition between operational / development coverage.
Gallagher’s Insurance Due Diligence team works with a wide variety of real estate lenders to help streamline the financing process from an insurance perspective. With capabilities across Europe, we monitor the challenges faced by lenders across the financing process to ensure that insurance related issues are identified swiftly, and innovative solutions are applied to enable deals to progress smoothly
The Walbrook Building 25 Walbrook London, EC4N 8AW
Let's talk
Arthur J. Gallagher (UK) Limited is authorised and regulated by the Financial Conduct Authority. Registered Office: The Walbrook Building, 25 Walbrook, London EC4N 8AW. Registered in England and Wales. Company Number: 119013.