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Distressed properties in the Belgian real estate sector

Property is distressed when the income generated by such property is no longer sufficient to repay its external financing. An example is the bank loan that can no longer be repaid in accordance with the repayment schedule (default).

Distressed properties are also referred to when there are indications that repayment obligations cannot be met in the (near) future. Determinants may include the case when the surplus of recurring income has become so insufficient that a limited setback or negative change in the market would jeopardise repayment.

Although several well-known real estate players have been under increased pressure in recent months, all in all, the number of known cases of effectively distressed properties in Belgium to date has remained relatively limited (e.g. Korea Investment’s forced sale of Toison d’Or in December 2024). Especially compared to other countries where there are signs that financiers tend to act more “strictly”.

Given the slower property market, caused by a combination of higher interest rates and thus higher financing costs, sharply increased construction costs and a reduced number of property deals, with demand for property struggling to keep pace with market supply, risks of an increase in distressed properties lurk even in the relatively stable Belgian market.

For real estate players with larger cash positions, distressed properties offer opportunities, even in current market conditions and with interest rates still relatively high for the time being. After all, acquisitions of distressed properties can allow real estate to be acquired below normal market value, provided investors are backed by the necessary expertise to manage such complex and (more) risky matters in order to nevertheless conclude quality deals with distressed sellers.

When does one speak of a ‘default’ in a credit file?

A default occurs as soon as the borrower fails to fulfil one or more of its obligations or acts in breach of its obligations to the lender. This can range from, for example, a change in the property company’s shareholders to being late with a repayment or failing to timely notify the termination of a lease.

In principle, every default gives the bank the opportunity to make the loan immediately payable, to request additional security or at least to receive detailed information on what caused the default and how it will be remedied. Practice shows that this often takes a more nuanced form, and that mutual consultation will often form the first basis for working towards a solution.

It is usually contractually provided that the borrower has the option to correct a default within a reasonable period, a so-called grace period or cure period. A bank will not immediately call a loan due for a minor reason anyway, because of its potential liability in that case.

A common comment is that credit documentation is nevertheless drafted rather unilaterally in favour of the bank, without much flexibility. On the other hand, the bank often provides a large part of the funds for the purchase of the property and therefore is potentially the party that suffers the biggest loss when things go wrong.

The relative one-sidedness and limited flexibility are primarily a call by the bank for ‘information and consultation’. The bank holds the plug, which should persuade the borrower to persuade the bank to allow the credit to continue, possibly subject to some adjustments, and convince it that ultimately, repayment is not at risk. In the other case, if the bank cannot be convinced, this de facto results in a credit file where there are big question marks about the (future) repayment capacity and where the bank will not hesitate to take faster action in case of defaults.

Which covenants usually apply in relation to property finance?

When financing an acquisition, the ratio between the market value of the property and the amount of the outstanding loan, or Loan-to-Value ratio (LTV), is often considered. High(er) LTV ratios mean that the loan represents a higher proportion of a property investment and are seen as riskier. The bank will therefore stipulate that the LTV ratio should not exceed a certain maximum, in the light of the borrower’s solvency and the intended transaction.

To take into account the periodic repayment of the outstanding loan and the fluctuating market value of the property, parties usually stipulate a periodic recalculation of the LTV ratio to check whether the borrower remains under the stipulated maximum percentage.

The Debt Service Cover Ratio (DSCR) reflects the ratio of available cash flow to the borrower’s payment obligations. As such, it provides information to investors and lenders whether a project generates sufficient revenue to pay off its (credit) debts. The DSCR ratio will be calculated on the basis of the available cash flow on one side, i.e. taking into account the rental income from the property after deduction of payments of operational costs and other non-recoverable expenses, and on the other side the portion of the debt to be paid with (at least) this net rental income, consisting of payments of principal, the interest and the other fees (fees) agreed with the bank.

A ratio below 1.00 equates to negative cash flow. The DSCR required by the bank will therefore be above 1.00. A ratio that is too low (due to vacancy or a reduction in rents, for example) means a structural problem in which the borrower will have to draw on its own capital, which is usually not a sustainable solution.

When it comes to financing new construction projects “on plan”, Belgian banks often require, as an additional covenant, that a certain share of the project is pre-sold before construction and financing can start. Percentages of at least 30 or even 40 per cent pre-sales are not uncommon.

When do the indicators come on?

The flashing lights certainly come on when LTV is too high and/or DSCR is too low, but equally when successive defaults may be recovered, but often still indicate that the borrower is struggling with its obligations.

The bank will then try to get a view on whether this is just a coincidence or an exceptional setback or really a situation that cannot simply be corrected by the borrower himself.

What steps can a bank take in the case of a distressed property?

If the bank determines that the amount financed is not repaid as stipulated in the loan agreement, it may opt to proceed with the enforcement of collateral provided by the borrower. In principle, these always include collateral on the property, notably a mortgage, whether or not combined with a mortgage mandate. A mortgage mandate allows the bank to execute an additional mortgage on unilateral initiative (e.g. in case of insolvency or threat thereof). The in rem nature of the mortgage thereby has the advantage for the bank that it is a preferential (mortgage) creditor on the (sales) value of the property.

Collateral can additionally take the form of a pledge on movable property, such as the real estate company’s shares, or a pledge on debt claims, such as the rental income from the property or debits on a bank account.

In addition, if the collateral established is insufficient or if a bank does not wish to proceed with its call for (e.g. commercial) reasons, the following options are also open:

  • obtaining additional collateral, i.e. possibly on other assets of the borrower;
  • guarantees of other persons/companies of the same group. However, the corporate interest must be kept in mind here, as the guarantor itself must be able to demonstrate an interest in guaranteeing a debt of another company;
  • Analyse whether a change to the repayment schedule could provide a solution, if the financial problems are temporary and/or if there is still room to spread the credit over time.

The forced sale of a distressed property in a difficult market can result in proceeds that often are substantially (30% to 40%) lower than in a non-forced (free) sale. The alternative measures mentioned are therefore often used to postpone a forced sale and/or work towards a voluntary sale in the meantime.

Banks also have an interest in keeping distressed properties out of the market. A (too) large number of them could create a ripple effect in the market and lead to a (further) downward effect on prices, leaving banks with even larger differences between the outstanding amounts under loans and the realisation value of the property.

What procedures are normally followed?

We look at this question from the point of view of a bank that has taken only a limited mortgage, and therefore, except for that limited amount, does not have priority over the sale proceeds of the property. It will try to secure its risk by seizure in particular.

The bank may proceed with a precautionary attachment (“bewarend beslag”/”saisie immobilière conservatoire”). To this end, urgency must be demonstrated, as well as the existence of a certain, claimable and determined debt. The precautionary attachment does not change the ownership or possession of the assets in question, but merely aims to make them unavailable. In concrete terms, this means that from the day on which the attachment becomes effective, the distraining party (the bank) cannot be subjected to any alienation or (additional) mortgaging of the attached assets.

Secondly, the bank may also proceed with an executive attachment (“uitvoerend beslag”/”saisie-exécution”), which aims not only at the unavailability of the asset, but also at its effective sale (either publicly or privately) to allow the bank to recover (part of) the amount it has lent. The executive attachment does not transfer ownership to the bank. It only gives the bank the right to sell the property. The distrained debtor is also not deprived of his rights of possession; he rather loses the right to dispose of the attached property (he may no longer dispose of it or encumber it with a mortgage or other collateral). Once the attached property is sold, the bank can claim the sum of money paid for it. If there are several creditors, the payment should take into account the ranking between these (preferential and/or ordinary) creditors.

The executive attachment can only take place on the basis of an enforceable title, such as a court order or a notarial deed. By attaching the letter of credit as an integral part of the notarial deed granting a mortgage, the bank immediately has an enforceable title in its hands.

A mortgage registration is usually only taken for a (very) limited part of the principal amount of the loan, among other reasons because of the costs and taxes payable on a mortgage (of 1% registration duties on the total mortgage amount). Parallel to the notarial mortgage deed, a mandate to mortgage will therefore often be executed at the same time. This allows the bank to act quickly in the event of a (potential) insolvency situation by taking out a mortgage registration for the remaining outstanding amount and obtaining the status of preferred creditor, without the requirement of direct intervention or approval by the borrower. As no effective mortgage is yet taken with this mandate, no registration fees or registration charges apply either.

In addition, the new Book 5 Obligations of the Belgian Civil Code may also allow a bank to anticipate (more) an impending or imminent non-performance of its (payment) obligations by the borrower. On the one hand, the bank can suspend its commitments when it is reasonably clear that the borrower will not fulfil its obligations under the financing (exceptio timoris), which may be relevant, for example, in case of a roll-over credit that allows multiple drawdowns. On the other hand, the lender can take even more far-reaching anticipatory action in case of a clear threat of non-performance on the part of the borrower – insofar as it is sufficiently serious – by unilaterally terminating the credit contract (anticipatory breach), whereby it can then proceed to seizure, as explained above, and enforcement. These possibilities are usually provided as such in the general terms and conditions of the credit.

The ultimum remedium of a ‘fire sale’

A fire sale occurs when a seller is forced to sell his property at short notice, probably at a materially reduced price. This is usually the case when the seller is de facto bankrupt, when his property is seized for other reasons or more generally when he is in tight financial straits.

The bank then has no room to look at solutions for the loan. In such a case, there is often no other option than to take what is left to take, if necessary via (forced) sale at a substantial loss.

For deals of a certain size, specifically developed insurance products can be used that take over (certain) sales risks from a borrower in default. Indeed, in a fire sale, the seller will not be able to provide the usual or required contractual warranties. To cope with this, insurance warranties in the form of “Warranty & Indemnity (W&I) insurance” can (synthetically) insure certain risks, the seller’s warranties then being covered by a W&I insurer, against payment of a fixed premium (either by the seller or the buyer). Despite uncertain circumstances, a ‘clean exit’ can thus still be made possible, to help facilitate a fire sale.

In the event of a fire sale, will investors ever see any of their money back?

Unfortunately, a real estate investor may not see any money back in that case. In all likelihood, the bank will be first in line, given its status as a mortgage creditor. In the ranking, the investor comes only after the (other) preferential creditors, so particularly with distressed properties there is little chance of anything remaining.

Some principles that a property investor can apply to prevent or to anticipate on slippage at the (earliest possible) stage are:

  • Conduct thorough due diligence, not only of the properties that will be invested in and the (legal) structuring, but also of the concrete (local) market conditions that may be relevant in a strategic assessment of the property in question;
  • Project-specific cooperation with experts such as property managers, legal advisers or real estate consultants is always the professional norm, but all the more important when dealing with the additional complexities involved in a distressed property situation;
  • Active management, including by implementing concrete cost-saving measures, establishing pragmatic management oversight and/or refocusing the relationship with tenants;
  • Clear delineation of the financial covenants (the ratios) and conditions (such as requirements on CAPEX, etc.) in the credit agreement, in order to have the clearest possible picture of the contractual commitments to the bank;
  • Clearly defined and as limited as possible events of default that may entitle the bank to prematurely terminate the financing and claim the amount borrowed, which admittedly presupposes de facto negotiations on the bank’s standard (base) credit terms;
  • Clear and realistic analysis and risk assessment of repayment capacities, and this on its own initiative rather than by waiting for an assessment or instructions from the bank.

13 January 2025

This article is an update of articles published in Expertise in December 2024.

Michael Bollen MRICS, Attorney-at-law Real Estate, Laurius

Gertjan Van Hoeyweghen, Lawyer Real Estate, Laurius