UK real estate lending was down by almost one-quarter in the first half of 2023, compared with the same period in 2022, and was skewed towards borrowers refinancing with incumbent lenders, according to the latest data published by London’s Bayes Business School.
Origination was down 22 percent year-on-year to £18.8 billion (€21.7 billion), per Bayes’ mid-year 2023 UK Commercial Real Estate Lending Report. “The overall reduction in lending was less than the reduction in investment, which was 40-50 percent down, according to consultants’ figures,” said Nicole Lux, senior research fellow at Bayes and the report’s lead author. “This shows refinancing is taking place,” she added.
Only 34 percent of loans backed acquisitions, amid an investment market slowdown. The remainder, Lux said, represented refinancing of existing debt. According to the data, 52 percent of overall H1 lending was in cases where borrowers refinanced with their existing lenders. Only 14 percent of origination was accounted for by sponsors finding new lenders with which to refinance maturing loans.
In recent months, debt market sources have speculated as to how much of this year’s activity has centred on lenders extending existing loan structures, rather than providing new facilities. However, Lux argued the bulk of the activity considered by Bayes to be refinancing involves meaningful changes to lending terms, rather than lenders simply rolling over maturing loans.
“Generally, this is proper refinancing, with changes to the terms in line with new market rates. This is considered a new loan,” she explained.
Bayes’ survey sample consisted of 37 banks, 11 insurers, and 31 other types of non-bank lenders. The results showed lenders are increasingly adopting a lower-risk approach. Senior lenders are typically writing loans within a 50-55 percent loan-to-value range. Whole loans are available at leverage levels within 70-75 percent, albeit provided by debt fund lenders with return targets of around 9-11 percent.
“Across sectors, average LTV has come down 2 percent to around 53 percent, which is a lot over a six-month period,” said Lux. “More equity is going into deals,” she added.
As leverage has decreased, lending margins have generally increased. For a 60 percent loan against prime offices, Bayes noted a 16 basis points increase in margins to an average of 277bps. Prime industrial margins increased by 18bps to 278bps.
UK banks refinance
UK banks – which hold the largest share of the country’s outstanding property loan book – were responsible for the biggest share of H1 loan origination which, at almost £8.6 billion, was 3 percent up on H1 2022. The report showed almost 80 percent of that origination represented refinancing of their own loans.
German banks also increased their origination compared with H1 2022. At £1.5 billion, their volumes were up 11 percent. The largest component was refinancing other lenders’ loans.
There was a significant drop-off in origination from the category badged ‘other international banks’, which includes US investment banks. Collectively, this group’s origination was down 43 percent on the same period in 2022, to around £2.9 billion.
Non-bank lenders’ origination volumes were also down. Insurers’ volumes were down 39 percent to £2.1 billion. ‘Other lenders’, which includes debt fund managers, originated more – £3.6 billion – although that total was 36 percent below H1 2022.
However, supporting market sources’ claims that alternative lenders are most visibly active in the market, less than 40 percent of origination by ‘other non-bank lenders’ was refinancing, with the bulk backing acquisitions.
Lux pointed out this is the second time since 2015, when Bayes took over the report from Leicester’s De Montfort University, that a decline in origination was recorded for private debt funds, with the pandemic year of 2020 the first time. “All other years, they have seen growth so far. It does show they are not completely crisis-resistant either,” she said.
As well as documenting lending activity, the Bayes report also examined the state of the UK’s existing debt pile. It found an increase in the default rate – from 3 percent to 3.9 percent – during the six months. All types of lenders reported instances of defaults and covenant breaches, with bank default rates typically within the 2-5 percent range, and debt funds reporting rates up to 11.2 percent.
“A 1 percent increase in the default rate over a six-month period is quite a bit of a move,” said Lux.
She believes it will increase steadily in the months ahead. “Many loans are hedged to 2025, meaning they will not breach ICR covenants while hedged. That means defaults are only gradually appearing on lenders’ balance sheets.”
However, Lux argued the approach to stressed scenarios is vastly different in the current market compared with in the aftermath of the 2007-08 global financial crisis. “Around the time of the GFC, many loans were held by SPVs [special purpose vehicles] and so there was little negotiation. Now, lenders and borrowers have one-on-one relationships. Borrowers have reputations to protect, and they are more likely to put equity into deals than walk away from them.”
Across the market, interest coverage ratios remain “stretched” according to Lux. The report showed ICRs range from 1.3x to 1.6x, according to property type, for 50 percent LTV facilities against prime properties. Lux described such levels as leaving “little room for additional debt”.
In the report, Lux said an increase in lending activity is expected for the second half of 2023, as borrowers decided to no longer delay asset sales or loan restructuring. She added that, with a significant proportion of the UK’s £178 billion outstanding loan pile needing to be refinanced in the coming three years, there will also be increased stress in the market.
On lender appetite, Lux suggested lenders are willing to provide financing, including to challenged segments like prime offices, but some are increasingly specialising in specific segments to position themselves as experts in chosen parts of the market.
“As a result, the practice of providing diversified loans across various property sectors and regions is being abandoned by most lenders,” she said. “It takes time to shift the make-up of a loan book, but we can see it happening. Logistics and residential are still favoured. Office is focused very much on prime.”
The report noted eight active lenders willing to provide loans of more than £200 million as of June, with four from the private debt market. “Some lenders say they can refinance any size loan, through private credit,” said Lux. “They really want to go for it and compete with banks.”
However, for most lenders, loan sizes have reduced. Loans of £80 million and above are typically undertaken in club deals.
Bayes noted the development funding pipeline has rebounded since 2020, providing financing opportunities. Development financing accounted for 20 percent of lending activity – at £2 billion – the majority of which was focused on residential schemes.
However, in one key area, lenders are reticent, Lux said. Despite the continued financing of developments, lenders are less willing to provide capital expenditure loans for refurbishments – many of which are necessary for landlords to comply with new building standards.
That reticence suggests more lender support is needed for building owners to make their assets sustainable. “Lenders have expressed the expectation that capital expenditures should really be funded through equity rather than loans, given the risk profile,” Lux said.