Roundtable: The calm before the storm?

Brexit remains the dominant economic and political issue in the UK, but its effect on the real estate lending market has so far been muted. By Stuart Watson

More than a year on, the uncertainty sparked by the UK’s decision to leave the European Union has become a fact of life for many. Domestic and foreign investors are beginning to take a more considered view of the altered economic landscape, although the future remains impossible to predict.

This summer, five real estate finance professionals gathered to debate the health of the post-Brexit market in the third Real Estate Capital UK roundtable discussion. Three debt fund lenders, M&G Investments’ John Barakat, PGIM Real Estate’s Andrew Radkiewicz and LaSalle Investment Management’s Daniel Pottorff were joined by host Iain Thomas, head of real estate finance at law firm DWF and Lisa Williams, head of the European loan servicing business at Situs.

The venue, DWF’s offices at 20 Fenchurch Street in the City of London – commonly known as the ‘Walkie Talkie’ – could be considered auspicious: the building was sold in July to a Hong Kong investor for £1.28 billion in the UK’s largest-ever office investment deal. Should that be considered an indicator that the market will retain its vigour even in the face of Brexit?

Uncertainty increasing

The Walkie Talkie sale followed hot on the heels of another London office mega-deal. In June, Bank of China (Hong Kong), HSBC and ING Bank closed one of the largest-ever UK real estate financing deals by funding Hong Kong property company CC Land’s £1.15 billion acquisition of the Leadenhall Building, the skyscraper known locally as the ‘Cheesegrater’.

“You don’t see many cheques of that size getting written in the UK,” says Pottorff, director of debt investments at LaSalle. “Post-Brexit, a certain class of sponsor – institutional investors such as pension funds and insurance investors who tend to invest on a hedged basis – pulled back. That has been offset by another class of investor – Asian primarily, who play the foreign exchange angle by buying real estate. The effect has been just as robust an investment market as there was before, but with a different kind of buyer.”

However, he admits that concerns remain over the eventual shape of a post-Brexit UK: “There is still a lot to be worked out about the UK’s relationship with the rest of Europe. Maybe it felt more uncertain right after the vote, but I think we see the uncertainty increasing as we get closer to the end date.”

Market uncertainty suppressed the volume of real estate financing transactions in the months following the referendum, says Situs’s Williams, but the market has already bounced back: “Not many deals were done in the third and fourth quarters of 2016. This year we have seen a
definite uptick in the UK. It is busier than last year. We either see very large deals or smaller £50 million to £100 million transactions. There are more deals in secondary markets and a focus on sectors like hotels, student accommodation and PRS [private rented sector] residential.”

DWF’s Thomas has spotted a similar pattern: “Post-referendum everyone shut up shop until the end of December and then started looking at things in January and those deals are now coming through,” he says. “A lot of lenders who previously wouldn’t have touched anything secondary or non-core are now active in that space. They are coming down the value ladder a bit to try to find deals.”

Barakat, M&G’s head of real estate finance, has noticed a “general sense of unease” in the market since the referendum vote. “We have seen a bit of movement back and to between risk-on and risk-off. Over the last 12 months we have seen people taking money off the table, whether that is through refinancing or sales, taking advantage of what have continued to be reasonably sustained valuations to cash out or sell.”

The market’s reaction to movement in interest rates will be crucial, he suggests. “You have the inevitable tapering coming from both the European and US central banks. The timing of that is uncertain, but seems somewhat imminent. The implications for sterling are important and we are at a late stage in the cycle. The question is, are we in an elongated late stage where things tick along at a one or two percent growth rate for some time, or will we see the inevitable turn in the cycle sooner? Sentiment is important. Sharp market reaction to any one of a number of things can have a meaningful impact.”

There is still a steady flow of global capital into UK real estate and real estate debt, but it prefers to target income over capital growth, argues Radkiewicz, PGIM Real Estate’s global head of debt strategies. “Over the last couple of years, and certainly since the referendum vote, there has been a sentiment amongst the investor and management communities to move away from growth-oriented investments into downside protection,” he says.

Diverse capital

As with sponsors, lenders’ approach to risk is being shaped by the lateness of the property cycle and the uncertainty engendered by Brexit. The clearing banks have adopted a slightly more conservative approach since the referendum, observes Barakat: “Individual ticket sizes have come down. We don’t see the clearing banks taking as big a position in any one deal as they would have done 15 months ago,” he says.

The clearers’ caution has placed increased emphasis on established, ongoing business relationships says Thomas: “They have raised the bar as far as entry is concerned. There are more checks and due diligence required to onboard new borrowers so they hang on to their existing customers and look after them. Most of the business we have
done for the clearers since the referendum has been for existing customers.”
It has also created more space for alternative lenders, observes Radkiewicz: “The core lending sector where banks and insurance companies operate has pulled in a little in terms of risk appetite, LTVs and the type of deals they will do. Liquidity has come out of transitional and development finance, giving opportunities to alternative lenders.”

Pottorff says lending margins on senior debt for core property ticked up by 20 to 40 basis points after the referendum and have now fallen back again as lenders try to place money in a tight market. However, he argues it is hard to generalise about terms in a market that features an increasingly wide variety of players and strategies: “The diversity of sources of both senior and junior capital in the UK is ever-increasing. You get more alternative lenders in the senior space in particular, and you are also seeing banks from other parts of the world. Indian banks for example have started coming in.” he says.

There is an increasing tendency for new entrants to access the market through syndication, says Williams: “Where there are large transactions, these are now syndicated to a large pool of investors both from the Far East and India.”


Williams identifies another growing trend in the UK market: “There has been a lot more refinancing this year. Loans that are two to three years in are starting to refinance, much more so than 12 months ago.”

That may ring alarm bells in some quarters. If sponsors are trying to take advantage of higher valuations to increase their leverage and extract equity then that could be an indicator of an overheating market that is breeding the conditions for a future crash.

Despite his comments on investors taking cash off the table Barakat doesn’t think that is what is happening in the majority of cases: “The absolute level of rates is just so low that people are trying to take advantage of locking it in for just that little bit longer because one or two years from now who knows what the interest rate curve is going to look like?” he says.

Owners are refinancing when they cannot achieve the high prices that they want in a sale, says Radkiewicz. He adds that where borrowers are extracting cash by refinancing that equity has usually been created by asset management to increase cash flow and not by yield compression in the market in general.

Pottorff argues that the UK lending market remains disciplined: “The total amount of debt capital in the UK is significantly lower than 2008. Maybe in 2015 we saw it creep up, but in 2016 we saw it creep back down again. To see that leverage effect which drives values and causes a crisis, you would see that starting to come through in the aggregate and you’re not. Occasionally someone tries it on and says ‘here is a much pricier valuation, can I have my equity back please?’ but generally speaking they don’t get what they are asking for,” he says.

Better fundamentals

The anticipated exit from the EU has hitherto been less damaging for the UK than some feared, but what of the future? Barakat says: “I think the eurozone will probably have better fundamentals over the next 12 months, but we have very strong domestic competitors in those markets and you have to pick out your opportunities. We will probably do more in euros in the next 12 months than we have in the last 12 months, but the UK still offers pretty good value.”

Radkiewicz believes that the fundamentals of the UK real estate market remain stable. Moreover he adds that there is a paucity of opportunities elsewhere in Europe: “The UK, Germany and France are two-thirds of the lending market and it is excruciatingly difficult to get a return in Paris or the German cities.”

Pottorff sounds a note of caution on Brexit’s impact on inflation, however: “Inflation has ticked up because of foreign exchange adjustments recently, but the other thing that is happening is that for the last few years the UK has been the jobs mart of Europe and that has kept a big discipline on wages.

However, immigration from Europe is slowing partly because of impending Brexit but also because large cities in Europe are creating more jobs. I wonder if you will start seeing more upward wage pressure in the UK in the next year or two as the supply of labour decreases. That is something you will have to think about when you are underwriting operational businesses.”

It seems that as yet the Brexit vote has had a limited impact on the UK real estate finance market. “It is quite a calm and measured environment at the moment,” muses Thomas. “People aren’t doing crazy deals, there aren’t crazy time-frames, documentation is fairly standardised. Let’s hope it is a calm that will last rather than being the calm before the storm.”

UK regions showing resilience

When the UK voted for Brexit, one school of thought suggested that while London would be protected by its status as a world city, investment in regional centres would suffer. A year on, that threat has yet to materialise.

“I have been encouraged by the resilience of UK regional markets,” says Radkiewicz. “Quite logically people are going for high quality in regional markets rather than more risk in London. Demand for real estate continues to be very healthy both from an investment and a tenant perspective.”

He argues that cities such as Manchester, Leeds and Birmingham, once regarded primarily as back office locations, are now benefiting from increased occupier demand and rental growth because of the expansion of technology, media and telecommunications companies keen to recruit from among their large student populations.

Those young people are increasingly inclined to stay put in the university cities, says Williams: “Millennials do not have to work in London now where they face a long commute. They are now working and living in cities like Manchester where they can work and live in the city centre.”

Thomas has observed an increase in the pace of development in the regional cities: “Manchester is our head administrative office and if you walk from Piccadilly down to Spinningfields where we are you can see the amount of building that is going on. In Birmingham the story is the same – a number of large employers have relocated operations to the city and this has supported the demand for suitable living space – for example we have just acted on the development finance for two 23-storey build to let blocks in the centre of the city. Another example is Liverpool’s waterfront which has been transformed over the past couple of years,” he says.

Schroder Real Estate is reported to be close to buying the No 1 Spinningfields office building in Manchester for £200 million. Radkiewicz says deals like that demonstrate the strength of investor demand for the UK regions, provided that the real estate is of the highest quality: “It has to be a shiny, new, well-leased product. The risk-adjusted return is attractive compared with London, but it is a narrower field of deals and projects.”