Sanne's Paloma Gonzalez was invited to a discussion with industry experts at Real Estate Capital Europe's Spanish roundtable. Participants observed that despite a difficult pandemic, liquidity has swiftly flooded back to the country.
As the fourth-largest EU economy, Spain is a natural target for real estate investors. Before the pandemic, assets in prosperous, growing, attractive cities such as Madrid and Barcelona were frequently near the top of pan-European managers’ wish lists.
However, Covid has had a particularly severe impact on the country’s prosperity compared with other European nations because of the large role played by tourism and services in its economy. GDP fell by 10.8 percent in 2020. Now, a recovery is underway, with the OECD projecting a rebound in growth to 5.9 percent this year, and 6.3 percent in 2022, driven by support programmes, pent-up demand and the gradual return of tourism.
The climatic change in the country’s real estate credit market has been similar in nature, with a sharp chill followed by a gradual thaw. Alberto López has observed the trajectory of the market from both a lender perspective, as chief executive of credit platform AEXX Capital, and from the borrower side as co-founder of investor-developer Urbania. “We are coming out of a deep downturn in the market. Covid impacted quite strongly on the capacity of the traditional lenders. Banks were very cautious and conservative, and most of the time they were focused on the loans they already had on their balance sheets.
“There was upward pressure on pricing for the debt that was available, and also some tightening of financial covenants. Now, more than a year and a half on from the worst of the pandemic, the banks are coming back to the table. They are still feeling the same pressure to be cautious, but they are looking at more new lending.”
Spanish banks have become more selective about the new business they choose to undertake.
In recent months, we have seen a huge difference, with banks taking on new transactions again, not just survival-focused refinancings. They have started very carefully, with very solid situations. They are not interested in every kind of real estate, and it is now more difficult for a bank to finance the acquisition of a hotel, or a retail asset. We are, however, seeing an increase for them to finance logistics deals with a tenant in place.”
One sector of the market that has clearly benefited from the pandemic, and where banks’ appetite for lending is undiminished, is data centres. In July, Nabiax, which develops and operates such facilities in Spain and Latin America, arranged a €320 million credit facility with a syndicate of Spanish and international banks, a transaction believed to be the country’s biggest data centre debt deal.
There was huge appetite from banks to extend that facility. We have not faced any financing troubles in the last two years. Conditions remain good and going forward we will probably look at extending a bit more to further expand our capacity in Spain.”
Both Spain and Portugal are perceived by credit providers as generally low-risk markets, although that varies by asset class, and there is still a lot of liquidity worldwide that wants to invest. Consequently, there is continuing appetite from both traditional and alternative lenders. The main difference is not so much in the margins of the loans provided by the banks, but in the leverage they are prepared to offer, and in the tightening of conditions and covenants.”
As in other European debt markets, the space ceded by banks as they retrench in the face of the pandemic has been occupied by a host of alternative lenders keen to deploy capital in real estate, many of which also play in the equity space and which frequently target equity-like returns. “There was already a void to be filled, which has been accentuated by covid,” says López.
With few banks willing to finance value- add transactions, that role is falling to alternative lenders, says González, and there are plenty willing to step up: “Almost every week we are seeing new debt funds being created that want to finance transactions in Spain, some backed by Spanish investors, and others by international institutions. This generates opportunity for third-party professional service providers like us, because managers do not always have their own teams on the ground. Some of those funds are not domiciled in Spain, but rather in Luxembourg – in this capacity we are able to service them in both jurisdictions.”
Moya says the growth of alternative financing in southern Europe is a natural progression: “Countries like Spain, Portugal, Italy and Greece have been dominated by banks that are now much more regulated, so they cannot lend in the same situations that they were doing before. However, borrowers are not yet accustomed to operating in a more diverse lending market.
“The market used to consist of either the banks providing senior debt, or alternative lenders with a high cost of capital seeking double-digit returns,” he says. “Going forward, sponsors will realise that it is normal to have alternative sources of finance available right across different parts of the risk-return spectrum.”
With more risk-averse traditional lenders providing lower levels of leverage, debt funds seeking equity-type returns can play a role higher up the capital stack, suggests López: “The banks need to understand that the new alternative lenders are here to invest in the capital stack by taking junior tranches, while they will provide senior debt, and that there can be a smooth co-existence between the lending parties. Sometimes, the banks see alternative lenders as overly aggressive, and they do not want to have a part of that same cake. In a single structure, there can be an equity investor, a senior lender and an alternative lender, with each receiving an appropriate risk-adjusted return.”
Some cross-border lenders were previously reluctant to finance midsized loans in southern Europe, but they are coming around to the idea because they have allocated capital to invest in the region, and realise it is the only way to access the market, notes Moya. He argues that mid-sized transactions are likely to provide the best opportunities for debt funds – Incus Capital’s own debt strategies tend to be at their most competitive when providing loans of €10 million to €50 million: “Local, traditional lenders usually compete for smaller tickets. When they do bigger tickets, sometimes they have to create a syndicate. And the international banks focus on large transactions, not mid-sized ones.”
Spain has sometimes been perceived as trailing its northern European counterparts in its progress towards a more sustainable real estate market. However, González notes that environmental, social and governance factors are now becoming “a reality and a concern” for all businesses in the country, real estate included, with performance in this area increasingly crucial to securing debt and equity funding.
“When developing, Urbania has set out 10 different measures that we implement, and report on afterwards,” says López. “But as a lender, we find borrowers in Spain are less familiar with the ESG agenda, so that can present difficulties. You can encourage sponsors to implement ESG initiatives, but you cannot force them. Lenders are still educating the market, and probably a year down the road we will see more than half of borrowers complying with at least some ESG requirements.”
Nonetheless, green loans are an increasing feature of the market – Nabiax provided a high-profile example in July when it extended its facility to €320 million. The loan agreement with 12 Spanish and international banks features a clause that will see five basis points deducted from the cost of finance if Nabiax meets sustainability targets, and a similar penalty if it does not.
Paja says: “Investors and lenders are strengthening their ESG efforts and that has a material impact on us because data centres are big consumers, not only of electricity, but also water. We agreed with lenders to reduce water consumption, and to secure a renewable electricity supply. There is a lot of work to do, and it is not easy because the operational requirements of our hyperscaler customers are huge. But it is vital, not least because we have seen a moratorium on data centre construction in European cities like Amsterdam, because of concerns that our industry could divert resources away from citizens.”
OECD analysis shows that tourism activity in Spain fell by an estimated 75 percent from April 2020 to March 2021. With so many Spanish businesses dependent on tourism, that might have been expected to generate distress within the real estate market, at least in the hardest-hit sectors such as hotels and hospitality. Buyers seeking to take advantage of fire sales have largely been disappointed, however, says Moya.
After covid happened there were a lot of investors coming to Spain to look for distressed situations in hospitality and there were some, but not many,” he says. “Leverage in the sector is not very high, and banks were supporting their clients in the sector. Where there were forced sellers, it was because the EBITDA gap caused by the pandemic could not be covered through extra financing or other means, and when there were forced sales, those deals were not done at distressed pricing levels.”
Local investors still have plenty of faith in the hotels sector, providing support for capital values, observes López. “We have great hotel chains and businesses, run by very experienced people that have performed well in the past, and there is nothing to suggest that will not be the case again. We have seen an increase in the number of tourists coming to Spain during this last summer.”
Investors evaluating retail assets on a deal-by-deal basis can sometimes still find opportunities, but the negative sentiment surrounding the asset class is a drag on activity, says Moya: “Market trends do not necessarily affect the performance of the asset, but they do affect liquidity, and the exit. In some cases, we can play a role at a specific moment when the risk perception of the project is too high for other players like traditional banks, then when the risk is reduced, another provider of finance can come in and replace us. However, if that exit is questionable, then for us the deal is questionable as well.”
In the commercial real estate sector, nervousness around future demand for office space has put a brake on activity, says González: “We have seen few transactions in recent months, or in retail. Most have been in logistics or in residential. It remains to be seen if that is temporary. I believe people will want to come back to the office and to have face-to-face interactions with each other. Maybe not in a full-time capacity, but a new normal will come back.”
Moya also expresses confidence in the sector’s long-term future. “We still believe in the need for good-quality office product in good locations, with the high levels of ESG and sustainability that investors and tenants require,” he says.
“In some sectors, the pandemic has even had a positive impact – logistics and data centres, for instance,” says Paja. Lockdowns have driven internet traffic, with a consequent huge increase in demand from the ‘hyperscalers’ such as Amazon Web Services, Google and Microsoft, which provide cloud computing capacity. “Their first movement has mainly been to Madrid, with the exception of Amazon, which is constructing its own campus in Aragon.”
A further driver of demand will be ‘edge computing’, which brings data storage closer to the sources of data to improve response times. Paja predicts: “Data centre operators will need to construct new, smaller facilities all around the country, starting with the large cities outside Madrid, then moving to smaller ones, because data centres need to be very close to the end users. That will mean increased construction in mid-sized cities like Valencia, Malaga, Seville and Bilbao. Then probably over the next five to seven years in all the provinces in Spain.”
Meanwhile, real estate investors have flocked to the Spanish logistics market. “There is a lot of competition to acquire properties, so prices are high and some investors are trying to find ways to acquire assets at more competitive prices; for instance, finding an existing building that needs some value- add work, or seeking sites for new developments,” says González. “Financing for those kinds of transactions is more likely to come from alternative lenders, rather than the banks.”
When financing development, traditional lenders prefer situations where a tenant is already signed up, which leaves some scope for debt funds to play in the sector, despite its competitiveness. “We can finance construction, taking the speculative risk without having a tenant,” says Moya. “As in many other cases when there is more risk to take than a bank would be comfortable with, we can step in and get a higher return. But most developers prefer to wait until the lease is signed and get bank finance at that point.”
“It is very difficult to compete with traditional lenders in logistics when everything is wrapped up,” agrees López. “We look to get involved at the very early stages by helping the sponsor to buy the land, even if it is not fully entitled, or there are other issues to be resolved, and therefore the price of the land is lower. It is more like an equity approach than a lending approach. We would love to do construction loans, but our cost of capital is too high.”
Multifamily residential is another sector that has been attracting increasingly keen investor interest during the pandemic.
“Multifamily build-to-rent housing has been a huge trend among institutional investors, who want to put money to work in lower-risk investments, and view rented residential as a core product,” says Moya. “We have closed big transactions in that segment with one of the pockets that we have for senior lending.”
He notes that Spanish banks have become more active in financing build-to-rent development, while their interest in backing the construction of housing for sale has waned.
As the discussion draws to a close, the participants consider the headwinds that could blow the Spanish real estate market off its seemingly steady course to recovery. For Paja, the inadequacy of the country’s power infrastructure is a concern: “The Spanish electricity industry does not have capacity where it is needed. If that is not addressed, clients will go to other countries. We are not there yet, but if the situation is better in Italy, our clients will create campuses there instead.”
There is peril in the potential for complacency, argues Moya: “There is so much liquidity looking to be put to work in Spain, and the perception of risk in the country is so good, that as lenders we have to be careful to take into account the potential downside in our scenarios.
“That might be through inflation, or an increase in energy costs, or raw material prices, or something that affects a particular asset class or location. We always have to have cushions in the business plan, and we are not seeing that within the business plans of some sponsors.”
López is also a “little concerned” about the effects of such a glut of available capital: “The market is very competitive and [it is] therefore hard to find alpha. When that is the case, people tend to bid more aggressively, and prices are hiked."
“It is also important to keep an eye on inflation, and how that will affect the economy as a whole. And a danger particular to Spain is politicians creating regulation out of the blue. That is not good for the property market because it creates uncertainty. That has been going on for many years, though. At the end of the day, this is a very solid country in which to invest, and right now global investors do not want to take Spain out of the running.”