Just three weeks into the campaign leading up to the 23 June referendum which will decide whether or not the UK is headed for Brexit, it’s clear that the uncertainty is already affecting UK real estate lending.
The adage that business hates uncertainty is nowhere more true than for investors in the cyclical UK commercial property market. If the UK votes to leave the European Union, firms are nervous about a protracted period of distraction, perhaps 2-3 years, and the negative effect that would have on the economy. If UK plc slows down, rental growth will stall or fail to materialise just at the point in the cycle when plenty of investors are relying on it coming through to justify prices paid in the last two years.
The head of lending in the UK at one European bank told Real Estate Capital that it has had transactions fall over in recent weeks, with Brexit the reason given for the bout of nerves. In these situations the bank was in prime position to lend, but the clients came back saying their investment committees had pulled out of the acquisitions.
Given that UK property values are seen as being full after a good run, with yields in large parts of the market at historic lows, this doesn’t seem so surprising. It’s much harder to make money on yield shift anymore, it’s all around rents. “People don’t want to look stupid”, the banker says. “Post 23 June, they don’t want their boss to turn round and say: ‘What? You committed to a central London office building at 3% four weeks before Brexit?’”
This could open a window for opportunistic investors to jump in and steal some bargains, but opportunity funds are among the most cautious. The banker’s examples included two US clients pulling out of acquisitions this year and while one has a core-plus strategy, the other is an opportunistic investor. For both it was a question of pricing letting risk.
Brexit is adding to a degree of caution that was already seeping into the offices of UK lenders. Talk to banks and they say there has been a gradual tightening of covenants over several months. In some instances cash sweeps are being set to trigger at lower levels if loan-to-values rise as a result of value falls.
Similarly, H2 2015’s modest widening in UK lending spreads, which reversed two years of sustained downward pressure on margins, appears to be holding into 2016. While low leverage deals in Paris and major German cities are still intensely competitive this year, UK lenders say they are winning business that is priced wider than equivalent facilities in H1 2015.
This is partly down to banks’ view of the risk at this point in the UK property cycle, but at least as important is that banks’ funding costs have gone up and margins are tracking them. Even as German real estate lender Berlin Hyp issued the first pfandbrief covered bond with a negative issue yield, banks’ other costs have been rising.
Last week Pbb Deutsche Pfandbriefbank unveiled record profits in 2015 after lending €10.4 billion, but said profits this year will be slightly lower and in Q1 2016 will be impacted by paying the European bank levy. For continental banks which do most of their lending in euros, another increase is the rise in the cost of cross currency swaps for UK business. At least one German bank has surprised borrowers and partner banks by quoting on a facility in net margins.
So with a potential Brexit adding to the general caution, few lenders are betting on 2016 being better than their strong 2015. As one puts it: “Last year we had the pedal to the metal; this year we won’t be pressing down quite so hard.”
Jane Roberts is Real Estate Capital’s consultant editor