This article is sponsored by Knight Frank
A diverse pool of lenders with substantial dry powder have proved to be active in the UK during a tough period for lending, marked by the covid-19 pandemic. Lisa Attenborough, head of debt advisory at Knight Frank, explains where lenders are seeing opportunity while they navigate these challenging times.
The UK market has had to grapple first with Brexit and then with the pandemic. How would you rate lender appetite for the UK, considering these challenges?
The UK has had a trying few years with Brexit and then, of course, the pandemic. It’s been a challenging time but demand for debt is higher than ever and is being matched by buoyant lender appetite driving supply.
We have liquidity being provided by diverse sources of capital: from European banks, other overseas lenders – Korean banks are becoming increasingly active – alongside private investors and the debt funds, which have been in high demand particularly over the last nine months.
Lender appetite is really strong in the UK at the moment. There are around 250 active lenders into UK real estate, so it’s a good market, it’s a solid market, and we expect that to continue in the second half of 2021.
Is there debt liquidity now because of available dry powder?
Yes, I believe so. In 2020, transaction volumes were significantly down, particularly from April through to September. This fed directly through to a reduction in the origination of new CRE loans. Many development projects were put on hold, and sales and acquisitions postponed. As a result, funds that had raised capital to deploy were, at the start of 2021, sitting on plenty of dry powder.
As H1 2021 drew to a close, we saw the reverse of 2020 in terms of activity. Every fund I speak to comments on increased dealflow, and that is a trend that we are also seeing in the debt advisory space.
In which parts of the market are you seeing more debt liquidity now?
Core-plus, refurb opportunities and ground-up developments are attracting significant appetite. I think that’s a function of the debt funds being active in that space. The funds’ return requirements are such that they are prepared to take a commensurate level of risk in order to achieve desired IRRs.
We have also obtained competitive terms for speculative logistics developments both in the UK and across Europe, not just from debt funds but from overseas lenders and European banks too.
In terms of the markets where we are seeing less liquidity, retail is still challenging, although we assisted in financing a shopping centre earlier this year and just this week secured indicative terms for a regional high street retail asset. In both of those cases, the tenant and income profile was robust.
Liquidity is also starting to flow back into the hospitality sector. We have spoken to around 25 lenders that are keen to deploy capital into that space and, consequently, margins are coming down after peaking last year.
Have you seen a change in loan pricing depending on sector fundamentals?
There’s a real disparity in pricing between different sectors. If you take the logistics space, for instance, there’s a wall of debt capital waiting for the right opportunities to present themselves, which is maintaining downward pressure on margins.
We have regularly seen investment facilities priced at below 2 percent this year. This has been further evidenced by the pricing we’ve obtained for a speculative development deal in the logistics space, with margins below 4 percent.
“We’ve seen an uptick in office refurbs and an equal uptick in lenders focusing on the quality of the asset post-completion”
Multi-let offices situated in core locations are also commanding competitive pricing, though the lender focus has shifted towards how borrowers will be addressing the change in working practices in a post-covid environment.
For best-in-class retail financing at 40 percent LTV we are seeing margins in the 4s which is reflective of lender caution.
Have you seen UK property debt entering underperforming territory due to the pandemic?
Yes. Almost all CRE loans contain LTV as well as cashflow covenants and, as a result of the various lockdowns in the UK over the last 18 months, it’s not at all surprising that we have seen portfolios, in the leisure and retail space particularly, underperforming.
What we haven’t seen, however, is widespread non-performing loan sales from banks. We have heard of some loans or assets being sold quietly in the background, but not to the same extent as following the global financial crisis. Where loans have underperformed solely due to the pandemic, lenders have, for the most part, worked in a collaborative manner, providing extensions and waivers where able.
Are lenders requiring different terms and covenants for loans backing covid-challenged sectors?
For new loan origination, terms and covenants have shifted for facilities which back covid-challenged sectors. Leverage and pricing are the key terms which have been amended, particularly in sectors such as retail and hospitality, where LTVs are now around 40-50 percent (down from 60 percent pre-covid) and pricing has increased.
Lenders have also approached new PBSA loan requests with greater caution over the last 12 months, with some funders seeking guarantees or cash cover to cater for any future dips in occupancy.
However, in a sector such as PBSA, where the underlying demand/supply characteristics are sound, we believe the debt market will return to pre-covid terms, assuming positive occupancy figures are reported in the forthcoming academic year.
For existing loan facilities that have breached covenants, lender response has been driven by the strength of the client relationship, as well as the outlook and revised business plan for each specific asset.
Do you think you are seeing more debt requests as a result of covid driving demand for capex into real estate?
Yes, we are – but not just due to covid. The increasing demand for capex into real estate is also being driven by environmental considerations.
In terms of covid driving demand for capex, the office environment needed to change in order to accommodate a post-covid workforce, both in terms of tightening health and hygiene requirements, and also in terms of transitioning the office into a place where people want to be.
We’ve seen an uptick in office refurbs and an equal uptick in lenders focusing on the quality of the asset post-completion.
Environmental considerations are also driving capex requirements. At the start of the year, lenders responded to this by offering green financing options which, in many cases, allowed for margin reductions to encourage such redevelopments.
However, lenders are now starting to wrap this into their risk analysis, thereby ensuring that all debt-funded refurbishments must have the environment as a key consideration.
According to the Bayes Business School’s UK Commercial Real Estate Lending Report, UK lending dropped 23 percent in 2020. Do you expect an increase in loan origination volumes by the end of this year?
Yes, I’d be very surprised if there wasn’t an increase in loan origination in this year. Anecdotally, every single lender I speak to at the moment is telling me how busy they are and how many new lending opportunities they are seeing. What this means in practice, is that lenders have the ability to pick and choose which transactions go to the top of the pile.
If they are presented with four value-add deals in Central London, it’s unlikely they’ll offer terms on all four. Instead, they will opt to lend against the deal which offers the best balance of return vs risk. But the fact that debt providers are seeing so much activity is a sure sign that loan origination in 2021 will be at higher levels than last year.
At Knight Frank Debt Advisory, we completed on around £1.3 billion (€1.5 billion) of loans last year. This year, we currently have £1.8 billion (€2.1 billion) in the pipeline – and we are only halfway through the year. So, it certainly feels a lot busier!