Octopus Real Estate: ‘Nothing has been typical in the last year’

The commercial lending specialists from alternative lender Octopus Real Estate explain how covid-19 has affected the UK’s small-ticket property loan market.

This article is sponsored by Octopus Real Estate

As has been the case across the wider UK commercial real estate finance sector, the coronavirus pandemic has had a significant impact on the market for sub-£20 million (€23 million) loans.

According to Ludo Mackenzie and Nick Westoby, respectively the head of commercial and fund manager with London-based specialist lender Octopus Real Estate, less investment activity has resulted in fewer financing opportunities. However, Mackenzie and Westoby say small-ticket borrowers have largely weathered the crisis. Further, they argue the undersupply of smaller-scale property loans means the sub-£20 million market remains a strong proposition.

Octopus – the winner of Real Estate Capital’s 2020 Small-Ticket Market Lender of the Year: Europe award – lends against residential and commercial property in the UK. In the commercial market, it provides bridge loans for up to two years on stabilised and transitional properties.

Its commercial term lending product, led by Westoby, through which it lends against income-producing assets for up to five years, was paused last year as the company sought to replace the retail funding behind the strategy. Octopus plans to resume commercial term lending in 2021, with a new source of capital.

Real Estate Capital caught up with Mackenzie and Westoby to discuss conditions in the UK’s small-ticket commercial property lending market.

How has covid-19 affected demand for small-ticket loans?

Nick Westoby
Nick Westoby

Nick Westoby: Nothing has been typical in the last year. Investment volumes decreased, so there were fewer opportunities coming through the door.

However, our commercial team completed 27 loans last year, of which 25 were smaller than £20 million. In 2019, there were around £14 billion of sub-£15 million investment transactions in the UK, so the addressable market is huge.

Demand for small-ticket loans will return as overall investment activity returns to some normality.


Ludo Mackenzie
Ludo Mackenzie

Ludo Mackenzie: There has been continued demand for commercial bridging loans since this crisis began. Borrowers have required finance for opportunistic acquisitions, and banks are reticent to lend against anything but the most vanilla deals. There are also distressed situations where borrowers need to recapitalise and refinance existing debt.

How did Octopus respond to the pandemic?

NW: Since Q1 2019, we have run scenarios across our loan portfolio, based on the peak-to-trough devaluations experienced during the

2007-08 global financial crisis, so we could understand where our loan-to-values might move in a very stressed scenario. We do not expect this correction to be of a similar magnitude to the GFC, but if it were, our commercial term investment loan book could withstand it with default ratios of less than 1 percent.

We lend against assets on the basis they are saleable or financeable, even in adverse market conditions. During the pandemic, borrowers have proved able to refinance loans from our commercial term book with other lenders or sell the properties. We paused commercial term lending in 2020, but we believe there is a long-term need for such finance and it is an underserved part of the market. We are securing new funding for this strategy.

LM: Although we are being more conservative, we have continued to see good opportunities despite disruption in the market. We continued to meet demand for bridge loans, which we fund through institutional capital.

We saw sensible bridge lending opportunities at slightly lower LTVs than before the pandemic, and slightly higher pricing.

Which property sectors are proving resilient in this part of the market?

NW: The pandemic has accelerated certain themes and is likely to permanently alter how we use certain asset classes, as well as investor appetite for them. Logistics, purpose-built student accommodation, prime offices, retail warehousing, supermarkets and residential development land are all likely to remain in strong demand.

In time, good-quality hotels with strong trading numbers will also return to good health. We have always had a low exposure to retail, with just 4.4 percent of our commercial lending in the last decade in that sector.

How has this crisis affected the credit quality of borrowers in this space?

NW: The borrowing entities that are active in this part of the market largely remain the same. In the small-ticket commercial property market, the sponsors we typically deal with are high-net-worth individuals and the smaller property companies.

They tend to have experience and a deep understanding of their local markets and their tenants. They usually have long leases on their properties. The liquidity of the types of properties in which they invest is also strong, either for selling or refinancing. So, lending in the small-ticket market has significant benefits.

How have you dealt with borrowers that have breached covenants due to the pandemic?

NW: We have worked with borrowers, allowing interest payment holidays and extensions to loans, to position both ourselves and the borrower in the best possible position to go forward. That has not been the case across all loans but is specific to those loans where the underlying tenants had trouble paying their rent, with implications for the borrower’s ability to service their debt. I suspect that was replicated across the wider debt community.

However, I have found during this pandemic that smaller tenants have proved more disciplined than some large occupiers in maintaining rental payments. In my experience, commercial loans in which underlying tenants are small-to-medium sized companies returned to a position of strength quicker than those loans secured by assets occupied by larger corporates. Overall, across our loan book, borrowers that needed to redeem their loans since the crisis began have done so, and those to which we granted interest payment holidays are now back to paying interest.

How have small-ticket lending terms changed due to the crisis?

LM: The market became quite opaque because there was limited activity. For our bridging product, we dropped our maximum LTV by 15 percent to 55 percent. We are gradually returning to 65 percent. We also increased our lending rates by around 100 basis points. We noticed borrowers requesting longer-term bridge loans than usual. I expect LTVs and lending rates across the market to return to pre-covid levels by the end of 2021.

NW: We did not see a massive shift in pricing in reaction to covid-19 across the commercial term lending market. Pricing for commercial investment debt is typically 5.5 percent, annually, fixed for the duration of the loan term.

How will this crisis affect the supply of finance to the small-ticket market?

NW: Since the global financial crisis, non-bank lenders have grown their presence to 25 percent of the UK lending market. We have seen a diversification of lenders, but the alternative lenders do not usually go as low as a £15 million ticket, so there is a lack of supply in this space for commercial investment debt. The pandemic, and structural changes in the commercial real estate market, could accentuate this dislocation. Lenders will need to focus on current loan books, rather than new lending opportunities. The high street and challenger banks were traditionally present, including for small-ticket loans. But regulation since the GFC has meant their new-to-bank lending has waned.

Small-ticket lending is the less contested part of the market. It requires pedalling harder to deploy the same amount as a debt fund lender might lend in the larger-scale market. But we have found that, in the small-ticket arena, it is possible to consistently deploy commercial investment loans under £20 million, with a core strategy – under 65 percent leverage – and still have strong pricing.

How do you think conditions will change this year?

NW: The focus will be on those sectors where we think there is opportunity driven by how the market is evolving, structurally. That includes industrial, supermarkets, purpose-built student accommodation, healthcare and automotive. If you have the discipline of understanding where opportunities will arise and you are very present in the market as it evolves, then you will capture good opportunities.

LM: The market has been disrupted and disruption leads to opportunity. Those investors with dry powder will be aiming to capitalise. There will also be borrowers which need to sell assets or refinance because their lenders are not prepared to extend existing loans. The vaccine rollout will have a big impact. Investment volumes will recover and we will see an increase in overseas investment into this part of the market, including from international high-net-worth individuals. Confidence should return to the market.