New loan origination in the UK property debt market dropped sharply in the first half of 2020 as lenders dealt with the impact of covid-19 on their existing loan books, according to the latest research published by The Business School at City, University of London – formerly known as Cass Business School.
The UK Commercial Real Estate Lending Report: Mid-Year 2020 showed new lending was down 34 percent year-on-year, to £15.5 billion (€16.9 billion) during H1. It noted that the UK lending market experienced its second six-month period of falling origination and higher lending costs, and so has entered a “new downward cycle”.
The report revealed 17 of the 76 lenders surveyed did not write any new loans in the UK during the period. On average, debt providers lent 29 percent less than in H1 2019, with the average volume of origination per lender down from £408 million in H1 2019 to £256 million in the first half of this year.
Of the H1 total, 43 percent was for acquisition financing and 53 percent related to refinancing. The remaining 4 percent was accounted for by extensions to existing loans.
Nicole Lux, senior research fellow at The Business School and the report’s lead author, told Real Estate Capital that many lenders focused on dealing with existing borrowers after the introduction of the UK’s covid-19 lockdown in March. “While some are extending [loans] each quarter, others might have already extended until Q1 2021. Many are granting short-term extensions and then reviewing the situation periodically,” she explained.
Looking forward, Lux said the key issue for the market in 2021 will be how lenders deal with borrowers that have struggled to collect rental income once the initial flurry of covenant waivers expires.
The report also provided insight into the key UK financing market trends:
Lenders increased margins
Across all property sectors, the report noted a 20-50 basis points increase in loan margins, dependent on lender type. UK banks and non-bank lenders including debt funds hiked margins by 45bps on average, while international banks, not including German lenders, applied the lowest increase, of an average 5bps. German banks increased margins by 16bps.
Loan pricing for prime retail assets increased by 48bps, with secondary retail up 34bps to a level only 10bps below the highest ever recorded by the research, in 2012.
Lux added she expects lenders to increase margins by another 25bps in the coming six to 12 months.
Leverage was decreased
Loan-to-values, the report showed, reached an historic low, at an average of 50-55 percent in new loan deals. Average LTVs for prime retail are at 56 percent – the lowest ever recorded by the research.
However, The Business School added that it is difficult to draw meaningful conclusions about the impact of the last six months on current loan book LTV levels, because material valuation uncertainty and exceptional market conditions have led most lenders to waive valuation requirements.
More selective lenders
While 39 lenders reported that they were willing to quote terms for prime offices, only 27 quoted for prime retail and 13 for secondary retail.
Lux told Real Estate Capital that lenders will be increasingly unwilling to write loans at all in some parts of the market: “Maybe by the end of the year we will see property yields rising by 50bps; for retail, they have increased already. Some lenders will just not lend to the sector.”
Development finance increased to 12 percent of outstanding loans, dominated by residential development. The report stated that some construction projects that were started in 2020 are expected to launch into a new market in 2022.
There were fewer big deals
Only 14 lenders wrote loans larger than £100 million, with most activity in the £30 million-£60 million size range.
The report said this was due to a lack of large investment transactions, rather than lenders’ capacity or willingness to write big cheques.
Lux said: “In the [2007-08] crisis, most lenders did not have the capacity, nor wanted, to underwrite loans above £100 million. But now they are willing to underwrite even £200 million loans. The issue is different now. There is not a credit crunch. Lenders have been lending below the levels they would have liked because there was a lack of larger transactions in the market.”
A funding gap is emerging
Lux explained that, in the next two years, £9.5 billion of retail assets and a further £13.5 billion of alternative assets including student housing, hotels and care homes will need to be refinanced. “Many facilities will be at 85 to 125 percent LTV at that time,” she said.
Last month, The Business School collaborated with investment manager AEW Europe on research that predicted a £30 billion refinancing gap for the UK property loan market, representing 16.6 percent of outstanding loans. Although significant, it is less than half the £70 billion gap seen in 2008-11 in the wake of the GFC, which accounted for 30 percent of loans.
Distress is still a way off
Lux said, in the years ahead, lenders and borrowers will need to negotiate to find solutions, including investors topping up their equity to protect assets against lender enforcement. “With significantly lower leverage levels and better bank capitalisation compared to the global financial crisis, distressed loan sales and receiverships are still a long way off. However, the real estate debt cycle has entered a new phase.”
She added lenders will not be able to extend forbearance in the long-term. “In the coming months, lenders will be less willing to be cooperative and will expect equity to step in. If they do not see cashflows, they will be less sympathetic to help borrowers where they do not see the turnaround of properties going forward.”
The UK’s debt pile increased overall
Despite the slowdown in lending activity, the report showed that total outstanding loans to UK real estate increased by 3 percent to £185 million during the period. The loan books of UK banks and insurance companies and international banks increased. Undrawn commitments reduced from £23 billion to £18 billion, partly due to cancellations of facilities, but also due to development activity continuing.
“Despite the regulatory curb on loan books, they have been expanding steadily and are 13 percent higher in 2020 than in 2017,” said Lux.
“Loan origination displayed the third lowest six-month period since 2010, and the development cycle has reached a new peak with £23 billion. At this point, it is unclear if 2020 was the trough, or 2021 will see further decline in origination and increasing LTVs.”