How the UK’s real estate debt market looked going into the covid-19 crisis

In January, before the covid-19 pandemic blindsided the real estate finance industry, consultancy firm Link Group conducted a survey of the UK property lending market.

The results of the Market Trend Analysis, Link’s fourth annual survey, provide insight into liquidity, pricing and industry sentiment shortly before the coronavirus crisis threw lending terms into disarray. Link gathered responses from 90 lending organisations during the first three weeks of January, providing a picture of lending market conditions going into the covid-19 crisis.

“The market outlook has shifted significantly between the point of data collection, in January, and the report publication,” explained James Wright, head of real estate finance at Link.

“Covid-19 was emerging in China as data was collected but was not seen to be a major threat to the market. The data is a relevant snapshot of the sentiment, appetite and capabilities of real estate lenders at the start of the year but must be viewed within the context of what has occurred since.”

Tellingly, only 2 percent of respondents saw a pandemic as the main risk facing the market back in January, hinting at the fact that, although coronavirus was already on peoples’ radar, few foresaw how much of an impact it could have on the UK market.

Instead, political risk topped property finance professionals’ concerns. Specifically, respondents focused on the UK’s negotiations with the EU, which they believed would impact the market towards the end of the year, ahead of the tabled end of the Brexit transition period on 31 December. The fact that 10 percent of respondents cited a global recession as the greatest risk shows there was already an expectation that global economic conditions were worsening, although few seem to have seen covid-19 as the specific trigger.

Real estate lenders began 2020 far more optimistically than they did in 2019, with the majority expecting pricing and loan-to-values to remain largely unchanged from the previous year, and almost half expecting to grow their lending teams. “An overwhelming 82 percent of lenders expected new loan origination to grow in 2020, the highest proportion ever,” said Wright.

“In 2019, the overwhelming consensus was for property prices to decline by more than 2.5 percent across the board with commercial values expected to fare worst. This year, around three quarters of respondents expected property prices to remain unchanged.”

In 2019’s survey, two-thirds of respondents expected LTVs on investment loans to remain stable. In the 2020 survey, they reported that average maximum LTV across all loan types had dropped by a modest 2 percent, to 67 percent. Hedge funds said they were offering the highest leverage, at an average 83 percent, followed by debt funds at 76 percent.

“There were no significant changes to lenders maximum leverage points for investment loans, with all lenders remaining within a 5 percent variance of their 2019 average maximum LTV,” said Wright.

In its previous three surveys, respondents said pricing for mezzanine loans was up, and for senior loans was down. The 2020 survey, however, showed a reversal of the trend, as average mezzanine margins were reported to have fallen by 93 basis points, with senior margins up by 38bps on average.

Wright noted that average margins fell last year and stand at an average of 773bps: “Bridge lending clearly remains a highly competitive space,” he said.

By lender type, pension funds and Pfandbrief banks were said by respondents to offer the market’s lowest margins for investment loans, at 188bps.

In the mezzanine financing space, UK banks indicated they are prepared to provide mezzanine debt at the lowest average margin of all lenders, at 600bps. “For UK banks this mezzanine is, firstly, very low leverage in comparison to most – at 70 percent average maximum LTV – and is generally restricted to existing clients the banks are seeking to support,” said Wright.

In last year’s report, interest cover ratios and debt service coverage ratios converged, although the trend reversed in the 2020 survey. Wright said this suggests a renewed focus on income during the loan term: “The convergence we saw in 2019 we put down to the increased focus on end-of-term leverage against value, via amortisation. This tends to be a predominate focus when lenders are concerned about refinancability.

“In 2020 we saw the trend reverse and lenders giving more consideration to the income during the loan term with less concern over the refinance. In actual fact income and refinancability are both significant challenges lenders are now contending with in 2020.”

In the development lending market, average maximum leverage remained constant at 74 percent loan-to-cost and 65 percent loan-to-gross development value. Alternative lenders offered the highest average maximum LTC at 82 percent. Middle Eastern banks were the lowest cost finance providers for land loans and for speculative commercial development. For part pre-let schemes, UK banks became more competitive, with Pfandbrief banks most competitive for fully pre-let schemes.

“North American banks and Pfandbrief banks halted development lending in the UK at the start of 2019 but resumed activity in this space in 2020. We suspect this was as a result of the increased certainty in UK political outlook which has improved securitisation and syndication prospects as well as, in the case of Pfandbrief Banks, the clarity on Pfandbrief funding of UK assets,” said Wright.

Lenders indicated a surge of appetite across property sectors, which Wright said indicates they have broadened their ability to lend across real estate types. The largest surges, however, were in the residential and student housing sectors. “It will be interesting to see if that intention holds in the face of covid-19. Anecdotally, we have seen lenders beginning to refocus on their core sectors,” explained Wright.

Maximum loan size decreased for the first time since 2017, from an average of £226 million (€252 million) and £148 million for investment and development loans respectively in 2019, to £171 million and £121 million in 2020. However, average maximum ticket size remains higher than that recorded in both 2017 and 2018, Wright added.

“We’ve seen a huge impact to our market as a result of the global pandemic. For now the long term effects are unclear but our data show a picture of the market which lenders were forecasting for 2020 prior to the outbreak. It may be that the expected market returns but right now the question is ‘if’ as much as ‘when’.”