Rising Rates, Tight Credit: Structuring Real Estate Deals Amid the Refinancing Crunch

The European commercial real estate market continues to navigate turbulent waters as elevated interest rates and constrained lending conditions reshape deal-making fundamentals. While the European Central Bank initiated rate cuts in late 2024 and into 2025, borrowing costs remain significantly higher than the near-zero environment that fueled the previous cycle's acquisitions. In Germany, one of Europe's largest real estate markets, this shift has exposed vulnerabilities in portfolios financed during the low-rate era, creating both distress and opportunity for well-positioned investors.

The refinancing wall looming over European real estate is substantial. Billions of euros in loans originated between 2019 and 2022 are maturing into a market where lenders demand lower loan-to-value/ loan-to-cost ratios, stronger debt service coverage, and more conservative underwriting. German banks, traditionally dominant in real estate lending, have tightened credit standards amid regulatory scrutiny and concerns over asset quality, particularly in the office sector where vacancy rates have climbed in major cities like Frankfurt and Munich. Prime locations in major cities generally appear to be the only exceptions where rent levels remain high and banks are more willing to consider (re-)financing. Also, ESG and statutory energy performance requirements influence underwriting. Assets with clear decarbonization paths are favored whereas transition capex is scrutinized.

Deal structuring has adapted accordingly. Sponsors increasingly turn to mezzanine financing, preferred equity, and whole-loan structures from debt funds to bridge valuation gaps. Joint ventures with equity-rich partners allow existing owners to retain upside while addressing capital shortfalls. Sale-and-leaseback (SLB) transactions have gained traction, enabling corporates to unlock real estate value without relinquishing operational control. In distressed scenarios, loan-to-own strategies and discounted note purchases or vendor loan structures provide alternative entry points for opportunistic capital. It is noted, however, that non-performing loan (NPL) transaction volumes are still below the higher volumes seen prior to 2020.

In this environment, the complexity of real estate financing transactions demands heightened scrutiny across multiple dimensions, from intercreditor arrangements and covenant structures to enforcement mechanics, tenant concentration, and evolving regulatory risks. At the same time, the market is witnessing a notable shift away from traditional bank financing towards a broader range of capital sources and deal structures, a trend that is particularly evident in larger portfolio transactions. Technology, including AI-driven tools, is increasingly shaping how these transactions are structured and executed, enabling more sophisticated analysis and streamlined workflows. Whilst the future trajectory of the ECB's key interest rate remains difficult to predict with certainty—and from a long-term historical perspective, current rates do not appear exceptionally high—the prolonged increased interest rates within the recent years will continue to influence refinancing dynamics and pricing expectations for underlying real estate assets. Against this backdrop, the search for and adoption of alternative financing forms is expected to remain a defining feature of the market in 2026.