Snapshot of the UK debt market for commercial property
The number of deals available in the market for lenders is lower than usual as some investors aren’t actively taking decisions to buy or sell.
Although appetite is more subdued and lenders are more conservative, due in part to Brexit uncertainty, resilience continues to define the UK economy, and lenders remain keen to lend to UK commercial real estate.
The number of deals available in the market for lenders is lower than usual as some investors aren’t actively taking decisions to buy or sell commercial property whilst the uncertainty of Brexit remains. As a consequence, lenders are competing for fewer deals, which is driving activity in the market. Lending is especially competitive for long-term leases and portfolios, where international, pension fund and insurer-backed lenders add to the mainstream lending pool. Income is still key for real estate investors and lenders are happy to lend against such property with good covenants.
Margins are competitive for good sponsors and properties, albeit retail lending, London-based residential and speculative commercial development remains challenging to finance. Lenders are increasingly reducing their exposure to retail by not extending new loans to the sector or asking for more equity when refinancing existing loans. While just over a quarter of UK commercial property debt was secured against retail assets in 2007, that figure was closer to 15% in mid-2019. Nevertheless, a preference for the prime assets of this category remains.
Loan-to-value (LTV) across most asset classes remains relatively conservative, with little real estate showing signs of over leverage in the way that it did during the Credit Crisis. This results from more prudent credit committees and stricter lending criteria post-crisis. That said, with limited transactional activity, the market value of many properties is difficult to determine, so the ‘true’ LTV may be masked.
The lending markets are diverse with mainstream lenders complemented by challenger banks, debt funds, private equity, family offices and the public sector. The diversity of lenders has increased significantly since the Credit Crisis, filling the gap left by mainstream high-street lenders as well as other investors looking for better risk adjusted returns than the direct property investments available in the market. Each lender has a varying appetite depending on their historical presence, losses in the crisis and current credit policy, including their preference for lending to certain geographies or sectors. Non-bank lenders, most significantly insurance companies, played a large role in increasing loan origination in the past year, lending more to UK property than German banks, which are typically the second-largest lender. UK banks still lent the most, but tighter regulation now moderates bank appetite for property lending.
International investors have seen a 15% discount investing in the UK from normalised exchange rates. This is leading to an increased appetite from international lenders, especially given the fundamentals of the UK remain the same despite Brexit. While most activity stills centres on the capital, some international lenders are looking to diversify their UK portfolio outside of London, seeking potential value growth in the regions, where loan margins are higher.
Valuations are diverse with political and environmental uncertainty pushing valuers to consider the downside position. That downside potential is difficult to quantify, so valuers are often coming out with very different valuations for the same property; this is also as a result of the transactional property markets providing few comparable transactions.
Overall, despite a slightly more cautious approach, the fundamentals of lending in the UK, backed by favourable legislation, property ownership rights, and solid insolvency regime remain unchanged, providing a positive outlook for the year ahead.
