Strength in diversity

Given the losses suffered by banks on legacy property loans, the real estate lending market’s diversification is of systemic importance.

The real estate finance market is more diverse than ever, as has been pointed out this month in several reports and research articles.

Findings published this week by the Investment Property Forum showed why this trend towards diversification is necessary. Banks, the lender group which traditionally dominated property finance, were hit hard in the last five years by losses on the original balances of their legacy lending activity.

“We estimate UK banks have suffered 17.5 percent cumulative CRE loan losses compared to between 9.5 percent and 12.5 percent across Europe,” wrote Hans Vrensen, one of the report’s authors, “far exceeding the 3 percent cumulative losses on securitised loans.”

The IPF-commissioned research also serves to highlight real estate finance’s evolution from a banking market to a sector in which varying types of organisation are active. The resulting competition has helped to drive down margins and has allowed banks to share risk outside the banking system by syndicating their loans.

Earlier this month, property consultancy Savills also made a point of market diversification at its annual Financing Property event. A tradition at the annual London gathering is for Savills to estimate the number of lenders; this year the figure was 250, albeit with a caveat that many within that total are likely to be lenders on paper rather than routinely active. That said, the total was more in the order of 50 back in 2010. showing just how much the lending landscape has changed.

Insurers, debt funds, challenger banks, peer-to-peer lenders and even property companies are these days providing debt to the sector. Given the losses made on property lending by the banks in the wake of the financial crisis, this spread of financial risk relating to property is surely a good thing.

However, while the market has diversified, the banks remain the dominant group, with 47 percent of market share of loan originations last year by De Montfort University’s reckoning. This means that the bulk of capital in the market is still focused on financing prime assets. That largely comes down to the fact that banks’ behaviour has changed significantly since the last cycle, as tighter regulation has greatly reduced their appetite for risk. As the De Montfort Report recently pointed out, many loan books are becoming more homogenous as regulatory pressure alters how banks do business.

The opportunity for alternative lenders is therefore in taking the risks that the banks won’t; alternative sectors, development loans, regional deals outside of Europe’s big cities, granular portfolios.

The evolution of the post-crisis real estate finance market continues and many types of lenders are keen to grow their real estate loan books, due to the fact that property remains a very financeable asset class. The more conservative approach being taken by banks is important if the mistakes of the last boom are to be avoided.

The fact that non-banks are in the picture to take on the opportunities outside the banks’ risk parameters provides borrowers with added options. The challenge for those alternative lenders is to provide capital to parts of the market where it is needed, while being mindful to avoid the types of risk that led the banks to their losses.