Lenders to property ended the year broadly happy after finding plenty of deals to finance during 2015.
Despite the widespread liquidity, there didn’t appear to be much pressure from borrowers to get lenders to relax structures and pile on the leverage; in short, discipline was maintained.
In many sub-markets and for specific types of lending, notably development, it was a great time to borrow and margins continued to fall. But in the second half of the year the talk was of a floor under pricing for debt for prime assets. One explanation was that lenders had simply got pickier after filling their boots in Q2 and Q3. But it now seems possible that there is more going on and 2016 could be the inflection point when borrowing becomes more expensive for some borrowers for the first time for several years.
It is partly linked to perceptions of risk: property markets are that bit further through the cycle and yields are back to pre-crisis levels for the best assets, as commentators pointed out in Real Estate Capital’s FIRST INSTALMENT OF 2016 FORECASTS.
Meanwhile, although in continental Europe, key interest rates turned negative in 2015 and are not going to be rising in 2016, the US Federal Reserve’s December 0.25 percent base rate rise signalled the change in the path of US and UK rates, to slowly, gradually, upwards.
The weakness of the euro as a result of the continued low growth/low interest rate/QE story and the differential with sterling may have other effects on lending and pricing for property in 2016.
For European banks which swap euros into sterling to lend in the UK, hedging costs rose sharply in Q4 2015, a cost which seems likely to have to be passed on to borrowers. Good for UK lenders, and for US banks which don’t generally raise money in sterling; not so good for most German banks which raise in euros and swap into sterling. And until the end of 2015, when French banks popped up as winners of the most competitively-priced deals, it had been German banks driving UK market pricing.
There are other factors which suggest borrowing may get slightly more costly in 2016. One is continuing volatility in financial markets – which nixed the CMBS market in the second half of the year.
Another is the snappily-named Base erosion and profit shifting OECD international initiative. The final recommendations were published in October and backed in the UK by the Chancellor in his December Autumn Statement.
Though prompted by a desire by governments to clamp down on tax avoidance by multinationals, the British Property Federation points out that one aspect in particular will make all leverage more expensive: the proposal to restrict the tax deductibility of debt.
And we won’t mention the potential expense of setting up a property loan database, being championed in the UK. That at least is unlikely to be an additional lending cost as soon as 2016.
Linklaters’ real estate finance partner, Trevor Clark, expects to see more development and operating asset financing in 2016:
“We are expecting 2016 to be another busy year in the sector. Investment into the UK and European market continues, from a variety of sources – we have seen plenty of appetite from overseas, including US private equity, North American pension funds and Asian and Middle eastern sovereign wealth.
“Market chatter about a peak in 2015 or 2016 probably doesn’t mean a market collapse can be expected soon. The most we would expect is perhaps a slow down in certain markets (for example, financing for prime London office investment assets) with investors looking for growth opportunities (particularly for those investors seeking higher yields) in more peripheral sectors and markets.
“We expect to see more financing around operating assets and platforms and more opco/propco structures. Lenders (including banks) are definitely liquid, with real appetite for the sector and are now actively supporting development deals again, particularly the larger tickets. We expect to see increased financing opportunities around the development sector both in the UK (where development has not kept pace with demand for office space in London, for example) and in Europe.”
The European real estate equities team at Morgan Stanley sees borrower discipline as a key reason to remain positive on the sector. In their 2016 Outlook, they say:
“Arguably the most important risk indicator (for property) – leverage – remains firmly on green. The last three major property crashes (1975, 1992 and 2009) all came after a period of bank balance sheet expansion with abundant credit availability for real estate. This is not an issue today, far from it.”
Many borrowers also said that the use of CRE debt is under control, including Schroders’ head of real estate, Duncan Owen:
“There are few signs of excess borrowing. In general, banks and other lenders have continued to take a disciplined approach to commercial real estate and although total loan originations in 2015 are likely to be around £50 billion, they are still well below the peak of £80-90 billion reached in 2006-2007.
“Moreover, while the IPD All Property Index initial income yield is low by historical standards at 5%, it is still comfortably above the yield on 10-year gilts at 2% and the consensus is that 10-year gilt yields are unlikely to rise to 3% until at least 2018.”
Turning to the CMBS market, Iain Balkwill, partner at law firm Reed Smith sees a reason for optimism in 2016:
“It will be interesting to observe whether those agency structures that feature the direct issuance by borrowers of bonds into the capital markets will finally rise to prominence. Indeed the current macro-economic climate potentially provides favorable conditions for the emergence of such structures.
“On the one hand, there is every indication that at times during 2016 there will be periods of capital market instability, which will manifest itself in volatile pricing of CMBS bonds, whilst on the other hand, there will be a plentiful supply of liquidity leading to increasingly tighter margins on loans.
“Against this backdrop, agency structures would appear to be an ideal solution for lenders as they allow them to meet borrower demand for finance whilst not having to deploy their balance sheet or expose themselves to a mismatch between the pricing of an underlying loan and widening spreads in the capital markets. 2016 could mark the beginnings of a paradigm shift towards a CMBS market composed of agency structures for the securitization of large single loans, and the use of multi-loan CMBS for a greater multitude of smaller loans.”