Laxfield: UK CRE debt market is ‘increasingly fragmented’

There was a partial recovery in borrower demand for property debt in the UK market during the six months to the end of Q1 2017, although the country’s real estate finance sector is “increasingly fragmented”, according to the latest research released by debt advisor and investment manager Laxfield Capital.

There was a partial recovery in borrower demand for property debt in the UK market during the six months to the end of Q1 2017, although the country’s real estate finance sector is “increasingly fragmented”, said Laxfield Capital co-principal Emma Huepfl (pictured) on the release of the firm’s latest research.

Sourcing debt for non-core assets remains a challenge due to the compression of risk-averse senior lenders’ capital on core property, the debt advisor and investment manager’s latest UK CRE Debt Barometer report showed. The research monitors borrower requests for real estate finance and compares it to historical levels monitored since 2013.

“A partial recovery in finance demand was evident from the beginning of 2017, but the market remains patchy, with wide variance in pricing as both debt and equity investors appear to be trying to find value,” said Huepfl.

Laxfield’s Alexandra Lanni, Emma Huepfl and Adam Slater

The volume of debt requirements during Q4 2016 and Q1 2017 increased by 10 percent, up from the previous six-month period, which spanned the UK’s EU referendum.

The loan count was strong, with 173 deals – compared with 169 in the previous six months – reflecting sustained demand at the smaller end of the market; between £5 million and £20 million. Larger-ticket loan requests increased by 30 percent by deal count from the exceptionally inactive previous six months, but remained lower than the long-term average.

Leverage requirements were slightly down from the previous six-month period, averaging 57.5 percent against 58.8 percent in the previous report, continuing a sustained theme of low gearing versus current value.

Although more than a quarter of loan requests by volume registered above 65 percent LTV, the pipeline of stretch senior or high leverage loans requests ran lower than in the previous two-year period. In the past year, the total pool of loan requests above 65 percent was £5.22 billion, significantly down on the previous two years, which saw £11.2 billion and £8.26 billion of requests respectively.

During the period, requests for acquisition funding were higher than refinancing requests. Laxfield noted that a substantial volume of refinancing did not come to the open market as lenders strived to generate lending opportunities from their existing portfolios, offering favourable terms to existing borrowers. Overall, the relatively strong acquisition pipeline of £5.5 billion ran 13% above the long-term average.

Large-ticket loans of more than £50 million continued to dominate overall requests by volume, but have been notably below peak level in the past year, with finance requests 18 percent below the long-term average. The firm attributed this to overseas investors financing themselves through domestic corporate credit lines, the strong lender focus on refinancing their clients and the highly competitive corporate funding available for investment-grade borrowers.

Pricing reflects senior lender risk aversion, with compression in core and wider pricing for more challenging assets.

Overall, expected loan pricing increased across the pool during the six-month period, although Laxfield caveated this by saying that expected pricing is notional as it does not always reflect where deals eventually closed. “Post-referendum” elevated pricing was still evident in Q4, although the report noted that conditions also reflected a fragmented market with terms varying widely according to asset quality, and depth of lending capital at different risk points.

By sector, offices had the lowest expected pricing of all sector categories, with average margins of 252 basis points against an average LTV of 55.6 percent. Secondary regional retail showed a 115 bps differential to core, as perception of increased risk associated with less prime assets increased.

Geographically, the split between London and the South East versus the rest of the regions was fairly even at 51 percent to 49 percent. Regional deals are boosted by portfolios which, due to their large average size of £90 million, bulk up overall totals. However, isolated by individual asset financing requests, London and the South East dominated finance demand, with a slight uptick in average deal size from £57.6 million to £68.1 million.

“The market is increasingly fragmented,” said Huepfl. “Demand is not matched by efficient supply in the regions; and outside core, the increasing cost of debt to borrowers may be a barrier to investing in, and improving, value-add assets.

“Whilst appetite to lend may appear strong, in practice it can be hard for borrowers to access funding without deep relationships and core assets to help support more entrepreneurial activities.”

The research, which is sponsored by the Property Finance Forum, records finance requirements at the stage when borrowers approach lenders seeking terms. Laxfield collates active requests for real estate finance and compares pools of data quarterly to track changing patterns of demand. The report references requests for funding received since January 2013, drawing on a total sample of 1,681 loan requests totalling more than £110 billion.