On refinancing, the way forward is together

COMMENT A small sigh of relief may have been heard in real estate boardrooms last month following the Bank of England’s decision to hold the base rate at 5.25% after 14 consecutive hikes. Though markets are anticipating further interest rate increases in 2023, there are signs that the rate rising cycle is nearing its peak and that inflation, at last, is showing signs of falling. The high interest rate environment has had an adverse impact on the UK economy. The real estate industry has also been significantly affected, with challenges including increasing costs of debt, falling real estate values – in certain areas – and rising construction costs. There is, of course, another puzzle that many landlords need to solve – how to refinance their current debt position. It’s a market-wide headache. Double hit In August, Robert Pike, executive director at Trimont, said that just under half (41%) of the loans Trimont services are due to refinance by the end of 2024, adding: “This is where things may become more difficult for borrowers and lenders alike.” Many borrowers looking to refinance existing debt obligations in the next 12 months or so are most likely to have raised debt pre-pandemic, at a time of incredibly low interest rates and when real estate values were, general speaking, higher than today. There is a potential double hit for borrowers. Many lenders are also lending a lower percentage of value, which makes the refinancing gap even larger. Accordingly, the ability to refinance may be challenging for some borrowers, and it will be important for both borrowers and lenders to try to find a way forward where possible. Firstly, for sponsors sat on cash reserves, they may well need to use those to reduce their debt exposure to a viable level for refinancing. They may also need to use some cash reserves to fund interest reserves if the cashflow position is particularly tight. Where fresh equity isn’t available, some borrowers may be able to refinance existing senior debt through a range of products, such as stretched senior, mezzanine loans, even preferred equity on top of traditional senior debt. However, the ability of borrowers to service that debt may be more challenging than before. Where no obvious exit route is available, it might be possible for borrowers to agree with their lenders short to medium-term extensions – perhaps coupled with covenant waivers in exchange for an increased margin. This can allow further time for borrowers to plot a viable refinance opportunity in the not too distant future, when hopefully market conditions will have somewhat stabilised. Of course, in some scenarios, there may be no other option than for borrowers, consensually or through enforcement, to part with the property. While lenders have all the armoury at their disposal to enforce, enforcement is still seen by many as a last resort. Overcoming adversity As lawyers in the real estate finance market, we have been involved in all types of amendments, workouts, restructuring and refinancing over recent months. We have supported a wide range of clients and understand that every scenario is very much unique and there is no one solution that fits all. The current operating environment is difficult, and while a stabilisation of property values could ease refinancing, the real estate industry must anticipate that a rapid return to the ultra-low interest rates seen in recent years is highly unlikely. The Bank of England has stated its plan is to “ensure that the bank rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term”, in line with its remit. So, with no significant drop in interest rates expected anytime soon, now is the time for the real estate industry to come together. Borrowers and lenders are going to need to be nimble, working in partnership and alongside their advisers to navigate tricky transactions. However, if the last three years have shown us anything, it is that the UK real estate sector is no stranger to adversity. We have overcome challenges before, and will, no doubt, again. James Spencer is real estate finance partner at Shoosmiths