Real estate lending falls in ‘another difficult’ first half

New commercial real estate lending in the UK posted a near double-digit fall over the past 12 months, with one industry leader describing the figures as reflecting the “poor state” of the investment market. The mid-year CRE Lending Research from Bayes Business School tracked deals from 69 banks, insurance lenders and debt funds. It found that loan volumes were down by 9.8% year-on-year in the 12 months to 30 June, at £16.7bn. Nicole Lux, senior research fellow at Bayes Business School, said the figures underscored “another difficult start to the year for lenders”. “They are competing fiercely for financing opportunities due to low transaction volumes in the UK commercial real estate market,” she said. “This continues the trend that started with Brexit in January 2020 and the significant impact of events such as the Covid pandemic.” Problems and pound signs Direct international banking activity has been declining since Brexit, the survey has shown over the years, falling from 33% in 2018 to 21% by June 2024. “While international and UK banks have lost market share over recent years, the undoubted winners are debt funds, which have seen their loan book market share nearly double to 23%,” Lux said. When insurance companies are included, she added, alternative lenders now hold 43% of outstanding real estate loans. “Non-bank lenders were able to step in to refinance many of the loans the UK and international banks were either unable to renew or simply write,” said Ben Thomason, director and head of debt advisory at Colliers International. “We expect to see some rebalancing of this in H2 as the forward curve softens and stronger sentiment returns to the market more generally.” Development finance hit a new peak, with £28.8bn of outstanding development finance and another £25.5bn of dry powder in undrawn facilities. UK clearing and regional banks accounted for the majority of this market. The two key assets for development finance are residential (provided by 49%) and student housing (46%), with margins compressing by 44 basis points to 414bps for prelet commercial development assets and by 68bps for residential development. Interest in prime offices and industrial properties remained strong, with more than 70% of lenders willing to  finance these assets. The cost of speculative financing declined slightly by 4bps to 477bps. For prime commercial and residential development assets, average loan-to-cost is 62%, but some 25% of lenders offer LTCs of 70%. Loan credit quality remains under pressure, with the average default rate close to 5% across lenders’ loans books, and 9.8% of loan facilities experiencing problems such as covenant breaches. This is particularly the case for smaller institutions with less than £1bn of loans, which Bayes said “lack the economies of scale needed to lend to higher quality assets”. Beds and sheds Peter Cosmetatos, chief executive of real estate lending trade body CREFC Europe, said the report “confirms both the market’s continuing preference for ‘beds and sheds’, and the poor state of the underlying investment market during the first half of 2024”. He added: “There are nevertheless positives to take from a lending market that is clearly both competitive and selective, with a good part of what is often termed the ‘debt funding gap’ rightly having been funded by equity. Meanwhile, the diminished role of international banks in the UK market is striking evidence of the challenges many overseas firms see in their home jurisdictions. It is to be hoped that we will see signs of recovery in the second half of 2024.” Nick Harris, head of UK and cross-border valuation at Savills, said: “The ongoing gap between buyer and seller expectations in terms of pricing has caused a further 10% contraction of new lending year-on-year. However, with lenders struggling to replace loan volumes following repayments, there is an abundance of liquidity chasing prime product – which remains limited – resulting in squeezed margins, slightly higher LTVs and more flexible debt structures. “Looking ahead, the five-year Sonia Rate has compressed by approximately 100 basis points over the last 12 months and borrowers should therefore benefit from a liquid and competitive debt market when transaction levels pick up. The position could potentially improve further if the Bank of England moves faster than anticipated in cutting borrowing rates.” Image © Oleg Gamulinskiy/Pixabay