Borrowers beware: headwinds will come

Comment: With both the Cass Commercial Real Estate Lending Survey and the Laxfield Group’s UK CRE Debt Barometer launched in the past few weeks, debt has never been more of a pertinent topic in commercial real estate, says Lisa Attenborough. With all the talk of a slowdown in the property market due the never-ending Brexit negotiations and with still no clear timetable for its implementation, if a decision is ever made, at least the debt market is providing us with a positive story. Both the number and range of lenders in the UK has never been so vast and varied. According to the Cass Survey, debt pricing is at an all-time low and margins on senior debt and prime office properties are at 199bps, down from 203bps last year. To complement this, Libor has also come down from the start of the year – five-year swap rates were at 115bps in April compared to 127bps in January – and Euribor continues to stay in negative territory. All in all, the UK commercial real estate debt market appears healthy, but what can we expect in the coming months? When interest rates are so low, the only obvious next direction is up. While we don’t expect interest rates to be increased in the near term, when it does happen lender covenants will be well-maintained (as since the GFC, leverage has been maintained at sensible levels). Investor returns however, won’t be protected. I recently arranged a 65% loan-to-value facility for a South Korean fund. Part way through the deal process, Libor moved out, which meant that the previously healthy cash-on-cash hurdles were no longer being met. To address this the investors asked the lender to reduce the margin which, unsurprisingly, was met with a swift and negative response. The moral of the story here is that while debt margins may be agreed at the term sheet stage of debt financing, the documentation and due diligence phase can often make deals drag on for weeks, if not months. During this time Libor can, and often does, fluctuate. There are ways of countering the effect of Libor fluctuations. For example, buying an interest rate cap or simply building in slack to initial cash-on-cash return assumptions, but the main focus should always be to work on minimising deal execution time. The second point to watch out for is lenders retrading terms as Brexit rumbles on. At the moment the debt market is robust and offers many options for borrowers. However, we have recently seen several examples of lenders retrading terms part way through a deal or, even worse, pulling terms completely following discussions with their credit colleagues.  We expect this is because lenders’ credit teams (those who ultimately provide consent for lending decisions), are becoming more and more cautious with Brexit looming over us. Indeed, one lender confirmed to me in the past week or so that they will not lend against anything in the City of London until Brexit is closed off, one way or the other. So while it may be a good time to borrow, borrowers should not ignore the headwinds that exist, as debt providers certainly won‘t be. Lisa Attenborough is head of Knight Frank debt advisory