Rebalancing looms as real estate lending enters new era

Players in the UK’s real estate debt market see a radical rebalancing of the market over the coming months, potentially undoing the achievements made in a steady first half of this year. The latest Bayes Business School UK Commercial Real Estate Lending Report, which drew on information from 79 lenders over the first six months of 2022, showed new lending at £23.7bn, in line with a year earlier. But report author Nicole Lux, senior research fellow at Bayes, said a refinancing gap is now looming for the sector. “Interest payments and property income were approaching a 1:1 ratio by June 2022, and with the five-year Sonia swap reaching 5.2% by the end of September, property income will not be sufficient to refinance some properties at these rates, leaving a potential funding gap,” she said. “Our analysis shows that property net income yields need to increase to over 6% across different property types, or property values need to adjust downwards by between 25% and 35% to reach a new market balance.” The report noted that all lenders still have breaches and defaults outstanding across their loan books, but said that they had “remarkably” resolved the biggest problem loans. British banks provided a little over a third of new financing, with international banks at 28% and debt funds accounting for a quarter. The alternative lender segment – debt funds and insurers – has now posted 12 years of continuous growth, growing by an average of 15% per year. Development lending accounted for more than a fifth of new origination and showed a post-pandemic rise in speculative development finance. Debt funds have put money to work in bigger projects and supplied close to three-quarters of commercial development finance. Small and medium-sized lenders focused most of their activity on residential development. Margins for prime office loans compressed by five basis points over the six months as competition grew. For other property types, however, margins rose by between five and 10 basis points for a 60% loan-to-value facility. The survey suggested that the rising cost of debt is forcing developers and property companies to change from a debt-funded acquisition model to a capital-light owner or investor model, and that some developers are now considering funding new projects entirely with equity. Loan origination by lender type, 1999-2022 Peter Cosmetatos, chief executive of lenders trade body CREFC Europe, said the market may be at “the end of one era and the beginning of another”. “It remains to be seen whether the market will be as resilient to the consequences of geopolitical turmoil and higher interest rates as it was 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,” he added. Euan Gatfield, head of EMEA commercial mortgage-backed securities and loan ratings at Fitch Ratings, said: “Elevated inflation, sharp increases in term bond yields and sustained caution over senior loan-to-value ratios all make this leg of the interest rate cycle different from 2005/06 – the last time rates rose. Then, pressure on interest cover saw many lenders pivot towards high-yielding, low-quality collateral of the kind that caused almost all the losses sustained in the global financial crisis. “This time around, credit rationing administered in the capital markets is dampening risk-taking much more quickly. In spite, or maybe because, of this, properties with rental yields that did not normalise through the pandemic – and in the case of industrials, actually dipped to record lows – will face a meaningful value correction as debt finance becomes markedly dearer.”   To send feedback, e-mail tim.burke@eg.co.uk or tweet @_tim_burke or @EGPropertyNews Photo © Christopher Bill/Unsplash Chart © Bayes Business School