Lenders struggle in equity-heavy UK market – De Montfort

The report shows a raft of organisations keen to originate debt, but deals more difficult to source.

Lending volumes in the UK real estate market dropped by almost a quarter during the first half of 2017 as lenders struggled to keep pace amid a more equity-driven investment market.

The latest six-month figures published by Leicester’s De Montfort University paint a picture of a functioning lending market, with a raft of organisations keen to originate debt, but deals more difficult to source.

“Lots of transactions were done through equity, or Asian money with no debt requirements in the local market”

– Nicole Lux

During the first six months of the year, £17.6 billion (€19.7 billion) of new loan originations were completed, which represents a 24 percent decline from the previous six months, and 18 percent down year-on-year. The university attributed this to fewer deals in the market requiring debt financing during the first six months of the year.

“Lots of transactions were done through equity, or Asian money with no debt requirements in the local market,” said Nicole Lux, senior research fellow at the university and the report’s author.

However, the report noted lenders’ assertions that there is a significant pipeline of deals due to complete in H2 2017, which could boost the annual figure.

The most recent full-year report, published in May, revealed a 17 percent drop in lending between 2015 and 2016; a decrease many attributed in large part to the impact of the UK’s vote to leave the European Union on the property investment market. However, Lux believes the driving factor behind the H1 2017 decrease is less a result of Brexit-related fears and more due to the increased volume of equity at work in the market, reducing the need for debt finance.

North American banks and insurance companies were two groups of lenders that wrote significantly reduced volumes in the first six months – down by 64 percent and 39 percent compared with H2 2016, respectively. In contrast, other non-bank lenders – predominantly debt funds – were the only lender group to buck the trend, increasing new loan origination volume by 9 percent from year-end 2016. Their share of all new origination grew from 10 percent to 16 percent during the period.

UK banks’ and building societies’ origination volumes declined by less than other lender groups, with £8.1 billion originated, compared with £9.4 billion in H1 2016. German banks also remained a major source of real estate debt in the UK, with volumes of just over £2 billion, down just 4 percent on the previous six months. However, compared with the first half of 2016, German banks’ volumes were down sharply, by 43 percent.

Allocation of new origination by type of lender (% of total origination). Source: De Montfort

Almost half of origination volumes in the first half of the year financed new acquisitions, with refinancing still commanding a slim majority of business, at 51 percent. However, there was some reversal of 2016’s trend, when refinancing accounted for 61 percent of business.

Development financing volumes received a boost during the period, following years of limited liquidity in the development debt market. The first half of 2017 saw the share of new debt allocated to such projects more than double from five percent to 11 percent.

It illustrates that lenders are searching for extra margin and shifting lending strategies, explained Lux: “Everyone is looking for yield. The market has been very competitive, so lenders are shifting to alternative asset classes, developments, or expanding to the regions or to Europe.”

In total, 21 lenders provided terms for fully pre-let development financing, at an average margin of 449 basis points, up from an average of 401bps recorded at year-end 2016. Only 10 lenders provided terms for speculative commercial developments with an average margin of 602bps, up from 556bps from year-end 2016, showing the increasing cost of development finance for borrowers.

Overall, the UK lending market remains conservative. Across the whole UK loan book, 93 percent of exposure was accounted for by loans up to 70 percent loan-to-value, representing a 10-year low. The average LTV for deals in the first half of 2017 was stable at around 58 percent across property types. Leverage has remained below 60 percent for the past 18 months.

Despite the decline in new lending, the total volume of committed debt identified by De Montfort remained stable at £191.4 billion, with £25.3 billion of undrawn facilities including higher volumes of development funding. Including outstanding CMBS and debt identified from financial statements outside De Montfort’s sample, the university estimated the entire UK debt pile to be in the order of £211 billion, up 0.9 percent over the six months.

Non-bank lenders grew their overall loan books by the largest amount, with an increase of 12.6 percent, followed by German banks, which grew their portfolios by 12.2 percent. UK banks grew their loan books by just 0.2 percent, while all other lenders’ loan books shrank.

In general, the latest De Montfort report reveals a liquid property debt market in the UK, with competitive pricing and lending terms for prime property. However, the decline in margins observed since 2012 reversed in H1 2017, with prime office margins up 11 bps to 209 bps by mid-year.

German and North American banks, which are subject to different lending rules from UK banks, continue to offer the most competitive pricing, with sub-200 bps available to borrowers in the ‘super-prime’ market, the report said. The average senior margin ranged from 213bps to 365bps for loans secured by secondary offices, retail and industrial property.

Key financing terms H1 2017. Source: De Montfort

Looking forward, the report notes that 78 percent of all lenders surveyed intend to increase loan originations for the second half of 2017 and that most remain positive about the UK’s prospects in the coming six months.

However, asked about their main concern, just over half of all lenders cited property market fundamentals, with many expecting property values to fall over the next 12 to 18 months.