Savills: UK CRE finance market has learned from its mistakes

The UK commercial real estate finance market might have reached its peak, but mistakes from the last cycle are not being repeated, according to Savills’ latest annual Financing Property research, which was presented this morning (7 June) in the City of London.

William Newsom, the firm’s senior director of valuations who has been hosting the event since the 1990s, used his last presentation to describe a lending market that is far more diverse and cautious than that seen at the peak of the last cycle. Newsom’s valuations colleague, Ian Malden, will take over his role in the research and its presentation from next year.

“The market today is very firmly not displaying top-of-the-market features,” Newsom told the audience at the Merchant Taylors’ Hall.

Referring back to May 1996’s research, Newsom pointed out that of the top 34 lenders active back then, only eight, including four clearers, remain active today.

Alternative lenders from outside the banking and institutional/insurance sectors have become an increasing force in the market, he noted. De Montfort University (DMU) recently calculated that alternate lenders from its sample were responsible for £4.83 billion of lending last year, although Newsom said that just the top ten alternative lenders from his research had lent at least £5 billion in the year to 31 March 2016.

In total, Newsom estimated, the true scale of UK real estate lending from alternative sources of capital could be in the order of £15 billion gross and £7.5 billion net in 2016, which would be a market share of 13 percent. He noted more than 100 active alternative lenders.

A total of 36 new lenders entered the UK commercial property lending market during the last 12 months, he added. In total, 180 new lenders have entered the market since 2013. By the end of 2015, insurance companies and alternative lenders had grown their respective shares of the market to 16 and 9 percent. Savills forecasts that these will increase to 18 and 13 percent by the end of 2016, while German, North American and other international banks will retain a 13 percent share each.

Newsom forecasts that insurance companies will be responsible for more than £10 billion of lending this year, on the back of £8.59 billion of origination in 2015, which was 58 percent up from the previous year. For insurance companies which lend off the gilt, the narrower spread versus the five-year swap is an advantage, with the spread having reduced from more than 100 basis points to 48 bps.

UK banks’ market share is forecast to decrease from 34 percent in 2015 to 30 percent by the end of this year, as a result of increased regulation and their rising cost of capital. Back in 2008, UK banks accounted for 70 percent of the market. Savills said that this shift has had a positive effect on the market; meanwhile UK banks remain, proportionally, the most active in the market.

With the cost of money at a record low and the yield spread high, property continues to be very financeable, Newsom said. Gross lending volumes in 2015 reached £53.7 billion, similar to the level seen in 2004-2005 and up 19 percent on 2014. However, net lending after repayments has only just returned to positive territory and lending to property comprises only 8 percent of banks’ total lending, the same level as seen in 2002.

“Looking back at many years of presentations, it is extraordinary to recall that in 2007, 64 percent of all the lenders DMU spoke to thought an 80 percent LTV was ‘no risk’; something that, happily, we can’t conceive of today,” Newsom said.

“Regulatory reform has had the desired effect, diversifying the market and allowing new entrants including the alternative financiers, who Savills believes are set to lend approximately £7.5 billion by the end of the year, which is some 50 percent higher than reported by DMU.

“Overall, such lenders are not financing speculative development and therefore are not bringing extra risk into the market. There are now property owners who have a strong preference to borrow from alternative lenders due to a perception that they are faster, skilled and offer greater degree of delivery,” he added.

Loan terms have softened in the last 12 months with interest rate margins on senior debt increasing by between 20 and 50 basis points since Q4 2015. LTVs have decreased. Senior LTVs have decreased by 2 percent and mezzanine by 4 percent (from 84 to 80 percent). Including mezzanine, leverage has been seen at up to 87 percent, although Newsom said this was not too hot.

“LTVs have decreased since 2015, although if mezzanine finance is included, this is capable of pushing total ratios to above 80%. This is of potential concern, but with the cost of money at a record low it can be comfortably achieved in today’s market,” Newsom said.

“The issue comes once the cost of money rises. Once it goes up it’s a whole new paradigm, but some businesses are being built around the premise that today’s low cost environment will continue indefinitely which, frankly, it won’t,” he added.

Addressing potential risks in the market, Newsom included Libor floors among financial structuring methods that are not widely understood. He questioned whether this could be the next bank mis-selling scandal in the making. Newsom also questioned whether the risks in peer-to-peer lending are fully understood, while adding that it only represents 1 percent of annual lending.

However, Newsom concluded that today’s market does not display the same features as in 2006 and 2007: “Everyone is worried about the next downturn, which is very healthy.”