CAPITAL WATCH: CBRE UK debt prospects forecast, Q3 2015

• Annual returns on five-year, senior UK commercial real estate debt are forecast to be 3.6% gross and 3.4% on a risk-adjusted basis at the end of Q3 2015, according to CBRE’s latest UK debt prospects quarterly forecast. This is a slight fall on Q2 2015, when returns were 3.8% gross and 3.7% risk-adjusted (see fig 1).

• The dip is entirely due to a 29 basis points decline in the five-year swap rate; margins actually inched up, by an estimated 5bps over the quarter, to around 2%, driven by a slight easing in competitive tension between lenders that had reached their 2015 targets.

• When measured on a return on risk weighted assets basis (RoRWA), gross returns improved slightly in Q3, compared to Q2 — from 3% to 3.1%, assuming the ‘strong’ category for slotting treatment. This is because RoRWA is calculated as a function of margin and fee alone, without the interest rate component.

CBRE Senior CRE Lending Returns Q3 15

• However, on a risk-adjusted RoRWA basis, returns fell, from 2.8% to 2.6%. This takes account of a higher default risk in Q3 compared to Q2, due to a less strong outlook for capital growth, according to CBRE forecasts. CBRE estimates that Q3 2015-2020 senior 65% loan-to-value originations have a 2% probability of default, double the 1% for Q2, and an annualised expected loss of 0.2%, compared with 0.1% in the previous quarter. Although rising, both probability of default and annualised expected loss remain well below previous, long-term averages.

• Mezzanine returns also declined slightly: to 8.7% on a gross basis and 6.7% on a risk-adjusted basis. This compares with 9% gross returns and 7.6% risk-adjusted returns for Q2, although the margin has not changed, at 7.3%.

• Senior commercial real estate lending continues to hold its own against non-CRE debt, with premiums to gilts and corporate debt holding steady at 2.4% and 1.4% (see figs 2 and 3).

CBRE Senior CRE relative lending returns

• However, senior CRE lending returns fell relative to those of CMBS CRE debt. CMBS spreads widened in Q3 as a result of softer market appetite. This was largely due to nervousness about key macro-economic concerns in wider financial markets — not least the continuing volatility of the Chinese economy.

• As a result, BBB CMBS now offers an 80bps premium to senior CRE debt, compared with a 20bps discount six months ago.

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