The role insurance companies might play as real estate lenders was debated recently in a panel discussion I took part in, hosted by law firm DLA Piper. Research for the firm found that insurers might write £28bn of new UK commercial real estate lending in the next five years, about £5.5bn annually – around 15% of the total debt that has gone into the industry over the past two years.
Loans will be medium-dated and “they may look to lend at higher loan-to-value levels than the 50-65% norm for loans of £50m and above”. While it won’t match the amount of maturing bank debt in need of refinancing, this new source of debt capital seems important. Current lenders in this field Legal & General, M&G, Canada Life, Aviva, MetLife and Cornerstone (part of US insurer MassMutual) have both the expertise and desire to expand their lending books. A potential future market entrant is Phoenix Assurance, while Pricoa (Pru of America) recently made its first loan.
True, the loans are ‘vanilla’ and lenders see them as a pure income play, with rigid lending terms and on core assets. The UK’s fledgling market is also light years behind the US’s 60 or so compet-ing annuity lenders, which are much more flexible in terms of what they will lend against and how.
The new UK lenders are focused on London and the South East and offer no residential lending or development finance. The last thing they want is anything complicated, like working alongside banks – and nothing carrying risk. So they have focused to a degree on healthcare and student housing, where rents have quasi-institutional guarantees. Hines, Derwent, and Great Portland have tapped into this market on keen lending terms priced off the gilt, not Libor.
US annuity funds’ loans are more flexible, with bank-like characteristics allowing for asset substitution, prepayment and part fixed/part floating loans. In the US, they also provide development finance. Perhaps some of these US lenders should enter the UK market, while bond funds could consider real estate in their search for higher but relatively safe returns.
So a new and growing source of competitively priced debt capital is emerging in real estate. Borrowing costs are falling and leverage levels may be greater from the most conservative of sources: pension annuity funds. The spread between income yields and borrowing costs could actually expand. A year ago we were poring over balance sheets to see which companies had short-term refinancing needs, which they were unlikely to meet. Now they may get longer-duration debt at a lower coupon than they ever imagined.
Interestingly, this is happening at a time when property companies are running away from gearing, although none that we are aware of are bearish on property – in fact rather the opposite. For the older generation, degearing seems counter- intuitive when interest rates are low and still falling.
If companies can debt finance themselves in the 4 per cents and buy assets in the 6 per cents, they will do so. As a perhaps more enlightened finance director told us “you want to be selling assets when the yield gap is narrowing and buying when it’s widening”.
Average debt costs are falling and debt priced off gilts should continue to do so. Wherever you think capital values and net asset values are heading, the earnings element of what REITs are producing is improving markedly. They are getting more efficient and creating earnings momentum, despite an apparently flaccid rental market.
This month’s round of half-year figures are not setting pulses racing, yet occupancy remains high, inflation a possibility and not a lot is being built. There is even tenant demand: global energy firm ENI is looking for West End space and Great Portland may be set to sign up Lane Clark Peacock for 50,000 sq ft at its Wigmore Street scheme.
Goodness knows what would happen if unemployment kept falling, the savings ratio started rising, household debt was tumbling and new lenders were entering the market…
Alan Carter is senior real estate securities researcher at Investec