Stressed And Distressed: Why This Time Will Be Different

With a recession likely looming in parts of Europe, it’s easy to believe that we will see the same long wait for investment opportunities as in the 2008 Global Financial Crisis. Yet Castleforge’s latest research, Distressed Opportunities in European Real Estate, explores why not all recessions are born equal, and why the current economic conditions mean investors should see opportunities appear sooner than they might think.

Those of us who began investing before the 2008 Global Financial Crisis remember that it took some years for the crisis to bring about investment opportunities. With a recession likely looming in parts of Europe, it’s easy to think a similarly long wait is in prospect. But there is good reason to think that stressed and distressed real estate opportunities will emerge more quickly this time.

When property values crashed in 2008, much of the banking sector was on the brink of insolvency. Without capital buffers capable of absorbing further losses, banks avoided selling foreclosed assets or NPL portfolios at steep discounts.

Instead, banks pursued a policy of extending and pretending, as they sought to accommodate defaulted borrowers by reworking loan terms to effectively bring them back into compliance. This allowed banks to avoid writing down bad loans during the height of the crisis. This approach was further supported by a sustained decrease in interest rates around the world, making it more expensive for banks to move bad loans off the books and lend again at a lower rate of return.

While these policies helped keep some banks afloat, they protracted the distressed cycle in real estate markets. Commercial loan defaults did not peak until 2012, and write-offs for UK banks did not return to pre-crisis levels until 2016. This meant that real estate investors had to wait for distressed sales to materialise.

While it is important that we learn our lessons from 2008, it is important to know that recessions are not born equal.

Firstly, banks are far better capitalised now.  On the whole, UK banks will enter this economic slowdown in a far stronger position. Many have slimmed down their commercial real estate loan portfolios, reducing the total value from roughly £250 billion in 2008, to less than £200 billion now. In addition, the quality of banks’ balance sheets has also improved, with LTVs on both commercial and residential loans meaningfully lower today than two decades ago.

Secondly, we are seeing surging interest rates across Europe. Higher interest rates should provide banks with a further reason to quickly enforce on defaulted borrowers, as lenders now look to replace old, low-yielding loans with new, higher-yielding ones.

Taken together, these factors mean it’s very unlikely we’ll see a reappearance of ‘extend and pretend’ since banks will be able to cut their losses on bad loans quicker this time.

There is no doubt that the coming period is going to result in a lot of pain in the market, and for people on the ground. But from an investment point of view, the banks’ willingness to ‘rip plasters off’ bad debt means smart investors should be prepared for opportunities to come more promptly down the pipeline than last time round.