Financing market

Now that inflation has receded to desirable levels and the deleveraging from the ECB is predictable, the funding market is also entering calmer waters. Highly volatile financing rates and challenging refinancing issues seem, with falling interest rates and rising capital values in 2025, to be largely behind us. Indeed, financiers appear to be more positive about the recovery of the commercial real estate market than investors. However, the implementation of Basel 4 for banks may slightly affect the financing playing field which will play into the hands of debt funds and insurance companies, among others.

Brief 2024 review

Refinancing gap virtually mitigated by flexible financiers

Last year, we assumed that rising interest rates, coupled with a significant decline in property values, created a financing gap, particularly in the office market. In practice, there were also challenging refinancings, but forced sales did not occur.

Financiers were mostly willing to be more flexible with the normally strict loan-to-value (LTV) criteria. This was supported by strong user markets, and thus a stable cash flow. Financiers primarily focused on cash flow opportunities to incrementally pay off the loan on top of the interest payments and to bring the loan back within the standard LTVs. In practice, this often resulted in LTVs reaching as high as 70-80%, while major banks typically set their LTV policy at around 55%. This mostly short-term refinancing responded to rising capital values, creating a better exit for both borrowers and lender. As a result, virtually no properties were sold forcibly due to the theoretical refinancing gap.

The main instances of lightly forced sales resulted from redemptions by end investors. These redemption requests require portions of funds to be liquidated in order to meet the payment obligations. For 2025, it is expected that these redemption requests will lead to dynamism in the office investment market, especially as many institutional investors are still facing a withdrawal of capital from their funds.

Stable interest rates with many active financiers in 2025

In recent years, the uncertainty surrounding financing rates and liquidity in the financing market has often led to hesitancy among investors. By 2025, the contrast with previous years could not be greater. The stable and predictable interest rates, combined with the large number of financiers in the market, provide numerous and clear financing opportunities. The five-year IRS swap rate is expected to remain more-or-less stable at its current level: around 2.10%. This brings volatility back to a level reminiscent of the period between 2019 and 2021.

The number of active financiers in the Dutch commercial real estate market will remain substantial in 2025. It is striking that they are broadly interested in all segments. The financing enthusiasm for financing remains strongest for living market properties and logistics products. However, it is evident that financiers are currently less hesitant than investors when it comes to offices. Additionally, there is increasing rationality among financiers regarding retail properties. It is particularly noticeable that the willingness to provide financing for medium-sized shopping centres has increased significantly.

We can say that the cost of financing has become significantly more attractive for all segments. Compared to the peak of the five-year IRS swap rate in October 2023, the all-in rate is now 130 to 150 base points lower. Importantly, however, the all-in rate is now also significantly lower than prime net initial yields. This in turn also allows investors to better optimize their returns: through the leverage impact of lower interest rates versus prime net initial yields. This may increase the number of active investors, which also increases competition in the investment market - supported by lower interest rates.

Financiers less focused on only the best offices

Despite the extensive discussion about potential operational risks in the office market, a large number of financiers remain active. In fact, over the past year we saw margins on office financing decrease – partly driven by persistently low vacancy rates. Notably, there is a discrepancy in interest between financiers - such as the Pfandbrief banks - and institutional investors. While institutional investors have a strong acquisition focus on new, centrally located offices, the interest from financiers is much broader.

The price polarization in the office investment market is not reflected in the financing market. Offices with relatively good location, occupancy rates and sustainability scores (label A+ or better) are well-financed. From a sustainability perspective, this even leads to a significant improvement in the financing portfolio for many financiers. This stands in stark contrast to Dutch institutional investors, who are divesting from these offices.

The fact that these often involve relatively larger financing tickets combined with a multi-tenant product makes it an ideal financing option, with risks assessed as low given the margins of 150 to 170 base points.

Living remains most popular financing product among major banks

Residential properties continue to be the most favoured financing product. The combination of sustainability, social impact and the low-risk nature of the living product results in average margins for the best propositions being lower, around 120-130 base points.

In addition to financing new construction, we see that primarily Dutch major banks are also significantly active in the privatisation market. As the living investment market is mainly driven by the purchase of existing complexes with a privatisation strategy, the interest from financiers in this product is also increasing strongly. Major banks appear to be the primary candidates to take on this type of financing, owing to their experience with interim repayments and the associated administration.

The main challenge for major banks lies in their sustainability obligations. Not all privatisation products meet their standards. For instance, major banks aim to have a real estate financing portfolio with an energy label of A by 2030. Often, the investment horizon extends beyond this timeframe, which obliges financiers to require investors to present a sustainability plan, despite the fact that the properties have a privatisation strategy. Investments for investors with a privatisation strategy typically cannot be executed profitably.

For residential complexes with relatively poor energy labels – which are often currently offered on the investment market – financing from a non-bank lender with less stringent sustainability requirements is more likely. This gap is being filled by a number of international insurers and a wide range of debt funds. The latter are often somewhat more expensive but are also willing to provide much higher advance financing.

Despite increasing vacancy rates, logistics remains popular

The financing market for logistics real estate remains robust. Although vacancy rates are visibly rising, this does not seem to affect the interest of financiers in this product thus far. The margins (130 base points) are comparable to last year. However, they are significantly higher for regular industrial spaces, which show margins of around 170-190 base points, despite this market still experiencing historically low vacancy rates. The hesitancy is partly due to the fact that many buildings in the industrial space market are outdated. As a result, these buildings need better labels in the short term to meet the desired financing product criteria. This also means that for a financing application, the asset management plan - including sustainability improvements - is essential for successful financing.

Rationality returns to retail finance

Slowly but surely, interest in retail finance is shifting to a broader range of subsectors within the retail market. Until recently, financiers were only willing to finance prime high street retail space and neighbourhood shopping centres with a substantial share of daily groceries (>70%). This focus is now expanding to include medium-sized shopping centres with a larger share of non-daily groceries. Recent years have shown that while the number of mutations may be higher in these types of centres, vacancy rates are not significantly different from neighbourhood shopping centres. However, there remains a difference in margins. For small district shopping centres, a margin of 150-160 base points is typically used, while for medium-sized shopping centres, this usually ranges from 180-190 base points.

For both the office market and shopping centres, financiers seem to be more optimistic than most investors. We still observe reticence from institutional investors, despite the vacancy risks being comparable to those of sought-after convenience shopping centres. Large centres can still be optimised, partly due to population growth and a strong demand for care facilities in central, accessible locations such as shopping centres.

When it comes to the PDV/GDV locations and construction markets segments, financiers remain cautious. Despite a low vacancy rate of 3.6%, they perceive significantly more risk associated with this type of retail space. This is mainly due to the fragmented ownership of PDV/GDV, which makes it riskier than planned shopping centres with one or a few owners. Consequently, the risk of departure is estimated to be higher. Alternative uses, such as converting to housing, do not alleviate this concern. In particular, this introduces considerable intermediate uncertainty and risk due to potential cash flow failures.

Nevertheless, we can say that there is once again more room among financiers for retail financing. This movement aligns with the relatively low risks present in the retail market in the medium to long-term.

Implementation of Basel 4 may lead to changes in the financing landscape

Beyond the specific segments, the implementation of Basel 4 on January 1, 2025, will change the financing landscape. It is expected to impact the capital availability of banks in the real estate financing market.

Ultimately, banks will be required to use standardized risk models instead of their own internal risk models. They will also need to base the risk of a financing on a prudent valuation rather than on market value. This new valuation approach is likely to limit the capabilities of banks in a recovering market, which could affect the availability and cost of capital. Overall, banks are expected to hold more equity as a buffer for real estate financing, which may increase the costs for future financing. Additionally, this could lead to a shift in requirements among financiers. It stands to reason that capital will be deployed less quickly for real estate financing, and within the segment, there will be an even greater shift towards properties with the least risk and larger-scale projects.

All non-bank financiers not subject to the Basel 4 agreement may benefit from this tightening. The implementation of Basel 4 is therefore expected to create opportunities for debt funds and insurance companies.