A conservative approach to lending is favouring real estate finance in core London, which is widening disparities in lending across the UK regions.
Europa Capital’s recent launch of a property debt fund to invest into the UK regions could help address the mismatch between supply and demand of real estate finance in the country’s regional markets.
The fund, which has attracted £100 million (€110 million) of equity commitments thus far, will far from solve the issue by itself. But the fund manager’s decision to launch such a product demonstrates the UK regions contain opportunities that lenders can capitalise on, perhaps encouraging others to tackle what is becoming an increasingly polarised lending market.
In the UK, new lending totalled £44.5 billion last year – almost two-thirds of which was in London and the South East, compared with 12 percent in the North, 11 percent in the Midlands and Wales, and 4 percent in Scotland, according to De Montfort University’s last Commercial Property Lending report. Lending in the UK capital increased from 30 percent in 2015 to 48 percent in 2016, the figures show.
And yet, Laxfield Capital’s latest data show that almost half of debt requests in the UK in Q4 2016 and Q1 2017 came from the regions – which reveals a lack of efficient property debt supply across the country.
Lender concentration on London is perhaps understandable given the uncertainty in the UK economy created by last June’s Brexit vote. But while a focus on core assets backed by well-known sponsors in a prime location such as London makes sense for conservative lenders, it does not justify this shocking regional disparity when it comes to property debt. Opportunities in the regions do exist.
While, in terms of loan pricing, London was static between Q4 2016 and Q1 2017, pricing elsewhere widened, giving an average spread of 63 basis points between London and regional deals, according to Laxfield. One Real Estate Capital source active in the regions notes the difference in margin between a senior loan for a core office asset in London and one in Manchester is 100 bps, with more income potential seen in the unofficial capital of the North of England.
In the regions, demand for office space has held up and the shortage of grade A office stock – particularly in Bristol, Edinburgh and Manchester – is set to support rental growth, a July report from M&G shows.
While office rents in the regions are expected to rise by just under 2 percent per year over the next five years, headline rents in the core office markets in the City and West End are projected to be revised down by between 5 percent and 7 percent by 2019, M&G says.
Their fixation on London means lenders are missing out on the opportunities regional markets offer for a range of debt providers. The decline in regional lending may be due to a drop in the number of smaller loans that traditionally have been issued by UK clearing banks. That creates potential for alternative lenders such as Europa to meet demand, even if its offering is focused on whole loans and mezzanine finance.
Despite the challenges in the regions, lenders seeking risk-adjusted returns can find largely unexplored high-quality assets. Lending in these areas requires building up local knowledge of smaller markets, which many will not have the willingness to do. However, breaking out of their comfort zones could lead to a healthier lending equilibrium emerging across the UK.
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