The latest update of the Cass UK Commercial Real Estate Lending Report, which was based on an end-2019 survey of the market, feels like a reminder of a different age.
It paints a picture of market conditions at a time when Brexit was the main talking point. Britain’s departure from the EU was seen as a credible threat to business, yet there were no obvious signs of an end to what had become an elongated real estate cycle.
The onset of the covid-19 crisis, however, has seen UK real estate market conditions change dramatically since the survey. But there is still much insight contained within Cass’s findings that is relevant to how the UK’s property debt industry will fare throughout 2020.
More analysis of the Cass report can be found here, but below are five observations on what the survey results suggest about today’s market.
1. Margins are up and could rise further: The report showed loan pricing increased by 6-16 basis points across prime property types, and by 20-35 bps for secondary property during the year. It is a trend that could be exacerbated by the covid-19 crisis. According to the author of the report, Nicole Lux, the underlying credit decline of loans could trigger higher capital costs, resulting in higher lending margins.
2. Refinancing will be a key driver of activity, again: Deflated investment volume in 2019 – partly due to Brexit uncertainty, partly due to high late-cycle pricing – led to just 46 percent of new lending being written to back property acquisitions. Investment in 2020 is likely to be lower still due to coronavirus, but plenty of debt will need to be refinanced – to the tune of £43 billion (€49.46 billion) in 2020-21, according to Cass.
3. Foreign banks will remain reticent, while debt funds face a test: In 2019, UK banks were responsible for 49 percent of origination at the expense of German banks and other international lenders. Brexit clearly tempered some overseas lenders’ appetites for the UK, and covid-19 could lead to a repatriation of foreign capital as banks focus more on clients in closer proximity. Although UK banks originated the most debt, ‘other’ non-bank lenders were the only category to grow market share. Those debt funds with most risk on their books will face challenging times, although some will see market disruption as a time to grow further.
4. Problem areas will become more problematic: The report noted lower interest cover ratios, which it said coincided with the first rise in the incidence of defaults since 2011. The absolute amount of defaulted loans year-on-year increased by 36 percent. Parts of the market – such as retail – which were already experiencing problems will come under further strain due to the covid-19 crisis. Cass forecasts loan write-offs and debt losses for the retail sector of up to £10 billion.
5. The overall market appears relatively stable: Cass data show the UK commercial property debt market has experienced a stable five years, with outstanding loans remaining within the £160-170 billion range. Loan books are dominated by senior debt held against standing properties. There was evidence of loan-to-values creeping higher. But 40 percent of outstanding loans are still below the 50 percent LTV mark. The market is not devoid of risk takers, with non-bank lenders in particular more exposed to subordinate and development loans. But the UK’s real estate debt market entered this crisis with far lower leverage levels and a greater spread of risk than was the case in the financial crisis of 2007-08.
All of Real Estate Capital’s covid-19 coverage can now be found here.
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