The Cass report: five key issues

The report formerly known as De Montfort highlights several trends that are shaping the market, including growth in development lending and the increasing role of non-bank lenders.

The headline message from last Friday’s Cass Commercial Real Estate Lending Report was the UK property lending market in 2017 was a stable affair, with lending volumes of £44.5 billion (€50.6 billion) almost unchanged from 2016.

On the surface, it suggests a market in which lenders are maintaining, rather than actively growing, their loan books. But dig a little deeper and the report highlights other key trends shaping the UK’s real estate debt markets. Here are five key points from the report worth thinking about.

1. More development finance suggests lenders want a little more risk.

New origination for construction schemes was up 13 percent year-on-year. Although total outstanding debt remained stable at £164.5 billion, there is an additional undrawn £34.5 billion of debt out there – mainly relating to development loans. It suggests lenders are more willing to take additional risk in this late-cycle market. Most of the development finance was focused on residential – a positive, because the UK desperately needs homes. Keep an eye out for core lenders putting money into commercial development schemes, however, as sponsors undertake ‘build-to-core’ strategies.

2. Foreign banks (except Germans and Americans) are lagging.

Origination activity dropped 34 percent in the lender group identified by Cass as ‘other international banks’ – foreign banks excluding German and North American institutions. This generally reflects the relative scarcity of the type of large, core deals that banks like to finance, rather than fears about Brexit. German banks, with their ultra-competitive pricing, remained active, while US banks have sourced business by backing private equity clients. Consider, though, that Asian lenders are understood to have provided debt to many of the Hong Kong and Singaporean buyers of London property. Many of these banks will not report to Cass and so foreign lending into the UK is likely to be higher than it seems.

3. Concerns about interest rates are building.

The performance of some loans – particularly unhedged floating-rate debt facilities – could be affected by the prospect of interest-rate hikes, surveyed lenders feared. It’s not seen as an immediate threat and most expect the prolonged cycle to continue, with plenty of financing activity yet to come. More immediate concerns surround structural changes in underlying property markets, such as the rise of co-working. Lenders should have potential interest-rate rises on their minds, even if there is no immediate panic.

4. Non-bank lenders are capturing more market share

Non-bank lenders – predominantly debt funds – continue to win market share of new origination, up to 14 percent in 2017, from 10 percent the previous year. The growth reflects the growing number of property debt vehicles in the market and it will continue as capital rushes to debt funds. It is positive to see a more diversified market, although investors should be alive to the risk of handing money to untested managers. Another interesting nugget from the report is that loan-on-loan lending is increasing as banks provide fund-level leverage to non-banks, creating the unusual situation where banks are fuelling some alternative lending strategies and finding additional yield in the process.

5. Borrowers want to take equity out of deals, but lenders remain cautious.

The report notes some property owners are requesting higher leverage to take equity out of assets. This is potentially worrying late-cycle behaviour and banks seem to agree; loan-to-values remain below 60 percent on average. This caution was reflected elsewhere in the report; margins for senior debt remained largely unchanged – a moderate 5 basis points average increase was noted across the sample for prime offices – while margins in the mezzanine space increased by 40bps-60bps. Indeed, junior and mezzanine lending has represented just 2 percent of outstanding loans in the past two years. UK real estate lending remains more vanilla than risky.