Laxfield Capital’s latest UK CRE Debt Barometer report highlights an incipient mismatch between the amounts of leverage that some borrowers are requesting and the amounts lenders are willing to provide.
The increased appetite for leverage has pushed the weighted average loan-to-value request to just over 60 percent, compared with 55.8 percent five years ago. There was a marked surge in 2018 in enquiries for loans with LTVs of 65-70 percent. These accounted for more than 34 percent of requests last year, up from 15.5 percent in 2017.
This does not mean that borrowers are necessarily getting what they ask for. Many requests may just be property investors testing the market to see if the incremental cost of additional debt would be accretive. In Laxfield’s view, leverage is “reasonably contained”.
Indeed, average LTV ratios remain conservative. According to data from Cass Business School, 80 percent of the UK’s total outstanding real estate loans in 2018 had ratios of below 60 percent. This compared with an average of 66.3 percent in the country’s prime office market five years previously.
A cautious approach to leverage is crucial in today’s market, given that some sectors are likely to be fully priced for this cycle. Although higher-leverage lending may be warranted in cases where the loan unlocks a corresponding increase in property value, lenders should avoid situations where a higher LTV would merely create more downside risk.
For example, Laxfield’s data show that leverage requirements against retail assets in the UK increased from around 60 percent to 65 percent. The surge becomes more apparent when calculated on a five-year basis, which shows the average LTV ratio to have shifted by more than 10 percent. This suggests that sponsors are seeking more support from lenders to replace existing funding against deteriorating values.
Providing higher leverage only makes sense where sponsors have solid plans to reposition assets. In such situations, there is an argument for lenders to provide a little more LTV where there is a clear upside – for instance when an experienced sponsor wishes to refurbish a tired asset or convert a property to a different use in order to unlock value. Such an approach may be best suited to non-banks with a higher risk tolerance than senior lenders.
It is also important for lenders offering LTV ratios of 60 percent or more to price their debt appropriately. In this way, they can ensure such high-leverage debt comes with a risk premium, helping to prevent levels of leverage in the market from becoming excessive.
Across the real estate lending industry, debt providers should remain vigilant on leverage as the property cycle advances. Although LTVs appear contained in the current market and are nowhere near the levels witnessed in the previous cycle, a loan written at 60 percent today will translate into a higher level of leverage if property values fall.
Nobody knows when a correction will come. But against a backdrop of political uncertainty, and with many real estate sectors undergoing structural change, lenders should use leverage as a tool by which to reduce risk across loan portfolios.
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