Market is polarised between conservative and higher-risk borrowers, reports Paul Yandall
The UK real estate debt market is polarising into groups seeking lower leverage, and higher loan-to-value borrowers hunting opportunistic returns, according to Laxfield Capital’s Q4-Q1 UK debt barometer.
Competition for assets, falling debt costs and rising leverage levels at which lenders are prepared to fund property are combining to split the market into two tiers, according to the data, which logged a pool of 624 loan requests totalling £58.8bn.
“Institutional and conservative investors remain firmly restricted in their appetite for gearing, but a growing band of investors seeks higher leverage and there is increasing disparity between the financing strategies of these groups,” says Emma Huepfl, Laxfield’s head of capital management.
More than half of the Q1 2015 loans requested by value sought loan-to-value ratios above 65%, compared to 45% for the six-month period Q4-Q1, implying investors began 2015 optimistically. The same figure was only 35% for Q2-Q3 2014.
Weighted average LTV ratios remained steady, at 56%.
Huepfl says: “Investors in the sub-45% LTV category are mainly institutions, REITs and some private family companies. More investors with short-term, high-return strategies are seeking high leverage debt.”
The total £11.3bn requested was down slightly on the previous period’s £13.5bn. Debt refinancings and acquisition finance were almost equal at 46.1% and 45.1% respectively, with equity refinancing at 8.8%.
Acquisition-related finance was 54.9%, up from 50.1% in the previous period, reflecting strong market turnover and growing confidence in debt availability. Debt demand for alternative assets also rose during Q4 to Q1, student and hotel assets forming 25% by volume, up from 17%.
Finance now comes before deals
Anecdotal evidence suggests that sponsors prefer lenders to work alongside them during acquisitions to maintain momentum towards a closing date.
“A couple of years ago, borrowers didn’t trust lenders to process an application in time and preferred to buy an asset then work out the debt strategy afterwards,” Huepfl says. “Now, there’s enough competition in the market that a borrower can bring a lender in earlier and use an acquisition date to keep everyone focused on getting the deal done.”
With margins compressing, lower swap costs and senior lenders prepared to push LTV levels closer to 70%, debt costs have fallen greatly. A sharp uptick in the marginal cost of extra leverage above 70% LTV levels indicates that this is now the inflexion point for mezzanine pricing.
Refinancing volumes were strong, with lender competition allowing borrowers to replace facilities secured in the past three to five years at tighter pricing. Expected margins were far lower on refinancings than acquisition requests: a differential of about 30%, up from 16% in the previous period.
“This correlates with lower average LTVs, but also reflects lenders’ desire for sponsors who hold assets for a longer term and have proven management capability,” says Huepfl.
After a period of muted demand, there was a rise in long-term debt requests. Lower pricing means requests for seven-year-plus loans are now at a 30bps discount to the next shortest band, six to seven years, or a 50-100bps discount to five-year deals. Seven-year-plus deal volumes grew to 20%, from around 7% in the previous period.