Savills: Lenders may cap leverage when the UK’s refinancing need is at its greatest

A spike in real estate loan refinancing in the UK market is due in 2020, although a correction in property values in parts of the market may lead some lenders to offer lower leverage than borrowers need, consultancy firm Savills has predicted.

Ian Malden and Nick Hume, of the firm’s valuation department, said pressure on key loan terms such as interest cover ratios and debt yields, notably in loans relating to parts of the retail sector, could lead some lenders – especially banks – to cap leverage when offering refinancing terms, potentially creating increased opportunities for alternative debt providers.

Savills cited the recent Cass UK lending survey, which noted 73 percent of outstanding UK real estate debt is due to be repaid in the coming five years, with the large quantum of 2015 vintage loans expected to lead to a spike in 2020. With yields already low, replicating existing levels of leverage could be a challenge if sustainable ICRs are to be achieved, the firm noted.

Discussing the increased diversification in the lending market at Savills’ 30th annual Financing Property event in London on 5 June, Malden suggested there are “at least” 240 lenders in the UK, including around 100 non-bank lenders. With frequent new entrants to the market and an increase in Asian banks aiming to finance investors from their home region, it is “impractical” to list the UK’s top 50 lenders today, he added.

Malden and Hume explored the potential effects of the rising cost of money, following rising interest rates, on the property lending market. The five-year swap rate has climbed from 0.8 percent in May 2017 to around 1.3 percent.

However, Malden argued there was no cause for alarm, with the lending market largely stable and able to cope with rising rates.

“Compared to a decade ago, on the whole the lending industry appears to be in a good place,” he said. “Regulation, prudence and a healthy market have generated low LTVs and high ICRs and a diversified lending market has reduced the prospects of ‘contagion’. There is no room for complacency, but given the level of equity in the market, it’s less likely that a borrower will need to hand over the keys to the lender if values were to fall.”

Hume said rising interest rates did not necessarily correlate with value shifts in the real estate market or worry lenders “so long as the overall cost of finance remains relatively low, as is currently anticipated”.

However, in the face of pressure on ICRs and debt yields, some lenders could be encouraged to offer lower leverage, benefitting alternative lenders prepared to go up the risk curve to generate higher returns, he added.

“This is particularly relevant to refinancing, as a gentle decline in values will create pockets of stress, as is already visible in certain areas of the retail sector,” Hume said. “Parts of the market might be unfinanceable on reasonable terms, with more borrowers turning to alternative lenders.”

Overall, he added, lenders have factored rising interest rates into their stress tests. For borrowers, the threat of higher rates is leading to more taking out hedging facilities alongside their loans.

Risks to the lending market, Hume said, include political and economic factors including the discontinuation of quantitative easing and Brexit; the increasing likelihood of a tapering in property values as the cycle runs its course; and a weakening of certain sub-markets, including parts of the retail sector such as secondary shopping centres.

Hume recounted a conversation with a lender who remarked there is “enormous complacency to parts of the retail market among lenders”.