New real estate loans drop by more than a fifth

New lending in real estate has fallen by more than a fifth in the first half of this year on the back of declining property values and steep interest rate rises, new research has found. Loan origination has dropped by 22% year-on-year to £18.6bn in H1, according to the latest Bayes Business School Commercial Real Estate Lending report. The decline marks the second-weakest year of loan origination from private debt funds since before Brexit. The decrease was viewed by the report’s authors as “generally still a good result”, given that the real estate investment market has plummeted by more than 40%. The report notes the lending markets have shown only a small increase in stress, since interest rate hedging is still in place on many existing loans. The overall loan default rate rose to 4% in the six months to June, from 3%. However, the difficulties of refinancing and new lending are becoming more visible, researchers said. While the report found good liquidity in deals larger than £200m, typically orchestrated by international investment banks, there was a reduction in overall loan sizes, with exposures exceeding £80m shared among consortiums of lenders to minimise individual risk. In the first half of 2023, the maximum loan size averaged at £107m, compared with £155m in 2022. The overall average loan was around £66m, 5.7% lower than last year. The findings showed £178bn of outstanding loans need to be refinanced in the next three years, indicating there are still tough times ahead for property. Lenders remain wary Nicole Lux, the report’s lead author and Bayes senior research fellow, predicted further lending and transactional activity in H2, driven by some borrowers’ decisions not to delay asset sales or loan restructurings any longer. “Some asset values might have been near their fair value point, but lenders still have doubts about the right value as a base for lending and are therefore very conservative with their loan-to-value ratios,” said Lux. The average loan-to-value level stood at around 50%. Association of Property Lenders president Neil Odom-Haslett said that while overall LTV levels across all lenders remain at “fairly conservative levels”, LTVs have reduced and margins have increased for new lending and refinancings. Nick Harris, head of UK and cross-border valuations and joint head of strategic advisory EME at Savills, said the current lending picture “arguably presents a further opportunity for debt funds and alternative lenders who are increasingly able to lend on lower-risk assets to meet their desired returns”. Harris said: “Commercial property transactions have been limited thus far in 2023, making the deployment of new debt more challenging. In addition, lending transactions are taking longer to conclude as there is a greater focus on due diligence in a more cautious market.” Peter Cosmetatos, chief executive of the Commercial Real Estate Finance Council Europe, said the market remains stable and diversely funded. Debt funds and insurers together accounted for 38% of new origination, surpassing UK banks and building societies for the first time. Cosmetatos added: “It remains to be seen whether the market will be as resilient to the consequences of geopolitical turmoil and higher interest rates as they were to Brexit and Covid, and who is best placed to finance the repurposing and decarbonisation that so much of the nation’s real estate needs.” Prime offices and industrial outperform By sector, the report noted continued “strong interest” in prime office and industrial properties, with 86% of lenders willing to finance those assets. In contrast, 32% were willing to back secondary offices. That said, the number of lenders willing to provide financing for prime offices slipped by 5% compared with six months ago. Conversely, 19% of lenders are actively offering loan terms for secondary retail, shopping centres and other alternative secondary assets such as healthcare, data centres and senior living. CBRE Capital Advisors head of debt and structured finance Chris Gow said: “We continue to see liquidity for all asset classes and loan types, but with a clear bifurcation between ‘the best of the best’ and the rest. “Comparatively lower levels of liquidity are evident for certain sectors such as office space. However, very strong offers continue to be received for well-located and well-specified buildings. “Living and logistics properties continue to be the most liquid asset classes with lenders, providing flexible and attractive financing proposals to increase their allocations to these sectors.” Resi developments lead the way Development lending totalled £2bn during the period and accounted for a fifth of new lending, the majority of which targeted residential projects. Just over half (51%) of respondents indicated they would consider financing residential developments, followed by prime offices and industrial properties at 44%. In contrast, 14% and 12% of lenders were willing to back development projects in the retail and shopping centre sectors respectively. The researchers said that while the price finding phase for real estate debt is still not over, the market is gradually adapting to it. Nonetheless, the number of transactions is expected to increase only slightly “at best” in the near future. More developer insolvencies are expected to occur as investors continue to wait for the bottom of the market. Additionally, the researchers said developers are more likely to face an equity crunch than a credit one, since “purchased” equity in the form of mezzanine is now “hardly accepted”, compared with the increased likelihood of gaining debt capital if developers raised additional “real” equity. The report also observed that, despite continued development lending, lenders appear to be less willing to provide capex loans for refurbishments required for landlords to comply with new building standards. Lenders have expressed expectations that capital expenditures should be funded through equity rather than loans, given the risk profile. To send feedback, e-mail pui-guan.man@eg.co.uk or tweet @PuiGuanM or @EGPropertyNews Photo © Scully/imageBROKER/Shutterstock