The latest research from Leicester’s De Montfort University shows the country’s commercial real estate lending was down during 2016, despite a rise after the EU vote. Daniel Cunningham reports.
Lending activity in the UK commercial property sector dropped during 2016 as debt providers anticipated and then absorbed the result of the country’s referendum on European Union membership, the findings of the latest UK lending market survey by Leicester’s De Montfort University has shown.
Lenders originated 17 percent less debt in 2016 compared with the market’s post-crisis peak, in 2015, the university’s Year-End 2016 Commercial Property Lending Report showed. In total, £44.5 billion (€52.4 billion) of new loan originations were completed during the year, down from £53.7 billion in 2015. Despite the pause after the referendum result, the market rebounded during the second half of 2016, which with £23.1 billion of loan origination was slightly more active than the first six months.
Now in its 20th year, the De Montfort report, compiled by former Deutsche Bank banker Nicole Lux, is the most comprehensive survey of real estate lenders in the UK market. In total, 77 lending organisations contributed, five more than in the previous survey.
Reflecting investors’ reticence about the UK market, 61 percent of dealflow during 2016 was refinancing; a shift from 2015 during which 55.6 percent of debt issued financed acquisitions. This benefitted banks with large existing client bases. The report also noted that finding finance for less well-known borrowers became more difficult, especially from large clearing banks.
However, banks and building societies – the market’s ‘traditional’ debt capital providers – remained the most prolific lenders, accounting for £35.4 billion of last year’s new business (see figure 1). Insurance lenders accounted for £4.6 billion, while other types of non-bank lenders provided the remaining £4.4 billion.
The volume of debt provided through syndicated deals dropped sharply during 2016. Around £4.2 billion was syndicated last year, down from £9.2 billion in 2015, based on data from 19 of the lenders surveyed. In addition, around £10 billion was reported as the value of participations in club deals by 37 of those surveyed, up from £8.8 billion.
Overall, the report noted, the UK commercial real estate debt market remains liquid, with competitive pricing and lending terms for prime property (see figure 2). However, lenders’ increased caution was reflected in lending terms and there was an increase in interest rate margins and a decrease in loan-to-value ratios during the year.
Margins had been falling since 2012 and they reached a post-crisis low in mid-year 2016. However, there was upward pressure on pricing during the second half of the year, with an increase of 10-15 basis points on loans secured by prime property. The overall effect, the report said, was a 25 bps decline in average senior loan margins for loans on prime properties, from 223 bps to 198 bps over the year. For senior loans secured by secondary offices, average margins remained stable at 263 bps by the end of 2016.
Fewer lenders were prepared to quote margins for secondary property. The average senior margin for loans secured by secondary offices, retail and industrial ranged between 263 bps and 291 bps, reflecting a premium of 65 bps for secondary offices over prime.
German banks offered the most competitive senior pricing on prime property, at 162 bps, which was up 23 bps across the year. Across the sample, UK banks and building societies decreased their pricing from 217 bps to 211 bps on senior loans, taking the whole of 2016 into account.
Risk appetites seem to have reduced, with bank lenders only selectively quoting junior or mezzanine lending terms, the report said. Insurers and other non-bank lenders were the most active providers of high-leverage debt. The average mezzanine margin for loans on prime property dropped from 956 bps to 871 bps during the first half of the year, and to 767 bps by the end of the year. Mezzanine financing for secondary properties declined from 1,000 bps at mid-year to an average of 872 bps, reflecting an IRR of 10-12 percent.
Across the sample, leverage dropped during the year. LTV ratios fell for the average deal during the second half of the year and are now below 60 percent for all property types, due to increased caution on property values, especially prime London assets. Traditional UK bank lenders especially continue to edge LTVs down to attract low regulatory capital charges. Indeed, a side effect of the Basel Committee’s capital requirements is that lenders are prioritising funding of mainly core assets, contributing to margin pressure in those sectors and more homogeneity in portfolios.
Average LTV provided by UK banks and building societies was 59 percent, compared with 65.6 percent at the end of 2015. Average maximum senior loan LTVs for secondary property fell below 60 percent for office, retail and industrial properties. The average maximum LTV for mezzanine finance was 75-85 percent.
On fees, the report noted that most lenders charged an upfront free of less than 100 bps, resulting in an average of 89 bps on a five-year investment loan. The lowest fees were offered by German banks, at an average of 77 bps.
The De Montfort report also polled lenders on terms offered for development finance. Of the 20 organisations that disclosed such details, the average margin for fully pre-let commercial development finance was 401 bps, up from 339 bps during the year. The average loan-to-cost ratio, based on gross development value, was 69 percent and the average arrangement fee 125 bps.
For loans on schemes that are just 50 percent pre-let, 13 lenders quoted terms, with the average margin at 480 bps and LTV of up to 65 percent. For speculative schemes, eight lenders quoted terms. The average margin stood at 556 bps, up from 384 bps.
Although development finance margins increased between 2015 and 2016, the report noted, overall development finance has become cheaper for borrowers in recent years. In 2014, lending margins were still up to 1,000 bps for 70 percent LTC.
A total of 19 lenders gave terms for residential development finance. For senior loans the average LTV was 66 percent and LTC 76 percent. Average margins increased from 434 bps to 528 bps over the year.
UK bank and building societies remained the key suppliers of development finance, accounting for 69 percent of all residential development funding and 44 percent of commercial development funding. In total, they completed £5.4 billion of a total of £7.7 billion of development lending.
UK loan pile
The total UK commercial property debt pile shrank slightly during 2016, with De Montfort recording a 2.1 percent drop in drawn debt to £164.8 billion across its sample. Including drawn and undrawn debt, the total remained stable at £191.5 billion (see figure 3).
Of the total of drawn debt (£164.8 billion), 77.35 percent was held by banks and building societies, 14.7 percent by insurance companies and 8 percent by other non-bank lenders. Junior and mezzanine lending represented 2.1 percent of outstanding loans, of which 76 percent was held by other non-bank lenders.
In absolute terms, only UK bank and building societies and other non-bank lenders increased their total book value. Overseas banks, as well as institutional lenders, experienced a contraction of their loan books, mainly due to maturing loans outstripping new business, as well as increased loan syndication activity by some lenders.
There were though no significant changes in market share among the various categories of lenders during 2016. Other non-bank lenders grew their market share of the UK loan book from 7 percent to 8 percent, while UK banks and building societies also grew their share by 1 percent. Insurance lenders and German banks’ share remained unchanged, while North American banks and other international banks lost 1 percent of the market (see figure 4).
The report also estimated the total size of the outstanding UK commercial property lending market, including lending outside of the sample. Including £26.7 billion on the financial statements of listed firms, plus £1.1 billion of UK-secured debt held by Ireland’s National Asset Management Agency and £17.1 billion of outstanding UK CMBS, the total was estimated at £208.7 billion, which was down 1.5 percent over the year.
At the end of 2016, a large majority – 91 percent – of loan exposure was in loans reflecting up to 70 percent LTV, up from 87.5 percent at the end of 2015. However, the value of loans in breach of financial covenants and in default at year-end 2016 was around £2.6 billion, 3 percent of the aggregate loan book of respondents. This compared with £10.4 billion and 7 percent at the end of 2015. Virtually all problem loans were written before 2009.
The UK’s real estate debt pile is increasingly comprised of new lending rather than pre-crisis legacy debt.
The loan maturity profile shows that 2020 will be a key year for refinancing, with a peak of maturities due to the high volume of origination activity carried out in 2015.
The report also provided an insight into lenders’ view on the market cycle. “It was frequently commented by respondents to this research that the lending market together with the underlying property investment market is experiencing an extended cycle due to low interest rates and economic support and that the market will remain buoyant until these external factors change.”
Ion Fletcher, director of finance policy at the British Property Federation, a sponsor of the report, highlighted two underlying trends; the rise of debt secured by London property – almost half of the outstanding total – and the relative dearth and high cost of development finance. “These contrast with the government’s objectives to promote economic growth across the whole country and stimulate new development activity, particularly for new homes. If these trends are driven by regulatory factors, policymakers should be thinking about how to mitigate them,” Fletcher said.