The New Paradigm of Real Estate Debt in Europe

Macroeconomic shifts, rate hikes, and the growing prominence of private capital is redesigning the European real estate debt market, which simultaneously faces a significant volume of commercial real estate debt approaching maturity over the next couple of years.

To provide a clear, current overview of this evolving landscape, we turn to the expert perspectives of two GRI Institute members who are leaders in the field: Jai Patel, Co-Head of Real Estate Debt at ICG, and Federico Valentini, Head of Capital Markets and M&A Advisory at Nhood.

Identifying the Funding Gap

The wall of debt maturities across Europe has exposed specific vulnerabilities in the market, creating a substantial gap between bank lending capacity and refinancing needs. Federico Valentini, who oversees Nhood’s global investment strategy and capital market activities across its diverse portfolio, pinpoints the areas where this shortfall is most concentrated.

“The office sector accounts for approximately 40% of Europe's debt funding gap,’ Federico explains, “driven by structural changes in demand and valuation declines.” Retail sits in second place, representing around 20%, particularly involving secondary shopping centres facing liquidity constraints.

Jai Patel, who co-leads the implementation of ICG Real Estate's debt strategies, points to operational real estate across Europe, such as self-storage, flex-living, and co-location data centres. These sectors seem to be attracting less credit appetite from banks, largely down to their lack of familiarity, explains Jai.

We are also seeing “higher loan to value refinancing in the traditional logistics and living sectors, resulting from 2020 and 2021 vintage development loan maturities - particularly in the UK and Germany,” continues Jai. “These business plans were underwritten with low cap rates which have significantly widened since the rate hikes.”

Geographically, exposure is seen across the continent. Around 20% of loans originated between 2017 and 2024 face refinancing challenges in France, and that number sits at 16% in Germany, primarily in office-heavy portfolios.

Meanwhile, banks in Central and Eastern Europe (CEE) have notably retrenched, and Iberia and Italy are somewhat undersupplied in terms of debt finance given the growth of private equity capital.

Where Private Debt Finds its Edge

As traditional banks prioritise senior debt for prime, ESG-compliant assets, private debt funds and alternative lenders are stepping into the resulting void in the capital stack to capture compelling risk-adjusted returns.

“These returns are commonly through whole loans and unitranche structures in the mid-market segment (EUR 30-75 million ticket size), where traditional banks have withdrawn,” says Federico.

He also highlights mezzanine and junior tranches for transitional assets requiring lease-up or capital expenditure, which offer internal rates of return (IRR) in the range of 10-12%. ”These opportunities are driven by reduced competition from syndicated loans and the growing popularity of hybrid strategies combining loan acquisition and direct lending.”

The Rise of Back Leverage

“There has been a gradual increase of back leverage use and capability in Europe over the last 5 years,” describes Jai, with “many debt funds using back leverage across their whole loan book to meet their double digit return requirements.”

Though helping to enhance returns to double-digit levels, back leverage comes with increased systemic risk as well as structural complexity.

Jai suggests that a combination of unlevered and modestly levered loans provides the best risk adjusted returns over the medium term. “However, if an investor’s return requirements are double digit to mid-teens, the widening capability of back leverage providers allows investors to access this return profile in levered first mortgage secured real estate credit.”

New Frontiers for Deployment

Beyond the core markets of the UK, Germany, and France, two less obvious European regions are seeing significant levels of new deployment of private real estate debt capital.

Amid bank entrenchment and strong sponsor demand for flexible capital, the Nordics are seeing significant debt commitments, including a EUR 1 billion joint venture targeting whole loans in Sweden, Norway, Finland, and Denmark, Federico describes.

Meanwhile, Jai highlights Southern Europe, namely Iberia and Italy, as regions seeing heightened deployment, attributing this to the “strength of the underlying economies and occupational fundamentals in many sectors”, as well as the “increase in international institutional capital attracted to these markets.”

Federico supports this view, relating “increased activity in bridge and construction financing in Spain and Portugal, supported by stabilising pricing corrections and renewed development momentum.”

“These transactions offer attractive short-duration, high-yield profiles,” explains Federico.

Resilient Asset Classes

With the rise in rates fundamentally repricing assets across real estate sectors, private debt capital is now keenly focused on historically under-financed asset classes that offer resilient income profiles or compelling value.

Favoured sectors offer strong occupational demand and robust cash flows, often summarised as "beds, sheds, and meds," including the living sector (residential, student housing, co-living), logistics, and medical-related real estate (life sciences, healthcare, senior living).

The defensive income streams and demographic tailwinds seen in senior housing and healthcare are attracting significant capital in these historically underleveraged sectors, says Federico. Similarly, the resilient occupancy and counter-cyclical demand in student housing is attracting private lenders, while banks continue to demonstrate caution in the sector.

Consensus among these market leaders also points to digital infrastructure - particularly data centres - as a key sector given the strong occupational fundamentals, boosted by the soaring demand from AI and cloud computing.

The ESG Mandate in Lending

ESG performance is now a critical component of lending, moving beyond mere box-ticking to become a core factor in loan covenants and pricing. “ESG is widely integrated into loan frameworks across the European market, both from a bank and debt fund perspective,” notes Jai. “Debt for non-ESG assets has much lower liquidity, so by nature commands wider pricing.”

“When we’re deploying capital at ICG we no longer just incentivise sustainable practices - it is a key consideration as to whether we will deploy capital or not, due to the potential impact on exit liquidity. If specific sustainability objectives are not met, we want to be compensated for the increased risk we are taking.”

Federico explains the current practice, noting that approximately 50% of lenders impose minimum sustainability criteria, including EPC (Energy Performance Certificate) ratings, carbon metrics, and GRESB (Global Real Estate Sustainability Benchmark).

“Around 30% offer margin step-downs for green assets,” continues Federico. “The typical spread benefit for green loans versus conventional loans is 5-10 basis points, with some sustainability-linked loans offering up to 15 basis points for meeting key performance indicators.”

The New Paradigm

The European real estate debt market is, thus, defined by a flight to quality by banks, a structural opportunity for private credit in transitional and mid-market assets, and the integration of back leverage for enhanced returns, albeit with caution.

As capital pursues new frontiers, such as the Nordics and Iberia, and focuses on resilient, alternative asset classes, the market’s new paradigm is clearly one where selective deployment, structural complexity, and uncompromising ESG standards will dictate success.

Thank you to our esteemed members Jai Patel and Federico Valentini for their invaluable insights.