Return to search

UK lending report: Loan market has reached the bottom

The report, compiled by The Business School, formerly known as Cass, reveals new UK lending dropped 23% to £33.6bn in 2020.


Real estate lending activity in the UK during 2020 was down 23 percent from the previous year, as the property sector absorbed the impact of covid-19, according to the latest research published by The Business School at City, University of London – formerly known as Cass Business School.

The decline in origination was almost double that recorded in 2019, when lending was down 12 percent, year-on-year, due in part to uncertainty surrounding the UK’s exit from the European Union. However, the report’s author told Real Estate Capital she believes the UK property lending market has reached the bottom, with this year’s lending activity likely to be similar to, or an improvement on, 2020’s.

The UK Commercial Real Estate Lending Report: Year-End 2020 showed new lending totalled £33.6 billion (€39 billion) during 2020. Of that figure, 42 percent was for acquisition financing and 53 percent related to refinancing. The remaining 5 percent was accounted for by extensions to existing loans.

Lux: The market has reached the bottom, with this year’s lending activity likely to be similar to, or an improvement on, 2020’s”

Nicole Lux, senior research fellow at The Business School and the report’s lead author, said 2020’s drop in origination was less severe than expected, but still significant. “The market caught up a bit in the second half [£18.1 billion was originated in H2 2020], but we need to consider that this is the second consecutive year of decline,” she said.

“The market has reached the bottom and is going to stay there for a bit. There remains this idea of caution. Nobody wants to make a move until things get better, which will possibly be from 2022 onwards.”

Lux added: “Although most lenders say they are open to new business, most are in a holding pattern until there is more clarity.”

The report also provided insight into the key UK financing market trends.

Distressed debt is piling up

The report showed a sharp increase in UK real estate loans experiencing some form of stress.

It noted the proportion of loans deemed “under-performing” increased from 4.8 percent of the UK’s outstanding property debt at the end of 2019 to 8.6 percent of the £191 billion overall debt pile recorded at the end of 2020. The most cited problem was loan-to-value covenant breaches as well as non-payment of the full loan at maturity, resulting in an extension.

“Just looking at the amount of defaulted loans reported, this increased from 3.2 percent to 4.6 percent year-on-year,” she said. “But when considering any debt that is being renegotiated or has covenant breaches, that is up to 8 percent, which reflects that a substantial amount of loans have some form of issue.”

The long-term implication of this, according to the report’s author, is a potential reduction in lenders’ appetite to provide new debt. “Lenders are busy enough dealing with their special services departments and the SONIA transition. This draws away their attention from new business,” she said.

Development finance is of increasing appeal

A total of £9.3 billion of new origination was for developments, compared with £8.7 billion in 2019, although the report noted that the amount dedicated to residential development was 10 percent lower than in 2019. Development lending accounted for 28 percent of last year’s origination.

Overall, development finance increased to 13 percent of outstanding loans, dominated by residential construction finance, which accounted for 9 percent.

According to Lux, this is a direct response to highly uncertain market conditions as lenders seek to look beyond the pandemic.

“During crisis periods, people focus on new developments, led by the conviction that by the time they launch it, in two to three years, the market environment will be much more favourable,” Lux said. “Development lending, therefore, has not been impacted by the pandemic, with all lenders being active in the space, although just open to specific projects.”

Lenders stick with prime sectors

The report revealed that, of the 78 lenders surveyed, 50 were willing to quote margins for prime logistics and 46 were willing to quote on prime offices. However, only 35 would quote on prime retail loans, with just 15 willing to consider secondary retail.

Generally, there was less interest in lending against secondary assets, with only 20 to 25 lenders active across the different asset types on average.

Lenders further increased margins

Across all property sectors, the report noted a 20-80 basis point increase in loan margins, apart from logistics. Prime office margins ended the year at 229 basis points on average.

The increase, however, varied depending on lender type. UK banks and insurance companies hiked margins by 31bps and 27bps on average, respectively, while non-bank lenders, not including insurers, applied the lowest increase, of an average 14bps. German banks increased margins by 19bps.

Lenders request cash reserve accounts

Lux predicted that, in the next two to five years, real estate lending will become more expensive, partly reflecting the increased cost of capital for banks.

The report also showed that lenders are taking measures to protect income, including requesting cash reserve accounts where necessary. The report noted that real estate investment is expected to become more expensive for landlords due to increased maintenance and improvement costs to meet environmental, social and governance requirements and necessary conversions or repurposing.

According to Lux, a significant number of lenders expressed concerns about landlords not having put some money aside for additional capex. “If you have an office building that is secondary space in a ‘B’ or ‘C’ location, which does not meet ESG requirements, that means that owners and investors might have to put more equity in to bring the property up to standard,” she said. “Lenders are still financing these properties but unless they start seeing cash reserves already in place for these expenditures, they will stop backing those assets.”

Lux added: “Cash reserves are being demanded either for capex, income to cover any tenant-related issues, and conversion. The market is transitioning, with lenders seeing the properties they have lent to being transformed into something else so they require a lot more from sponsors.”

Leverage remained low

Loan-to-values, the report showed, reached a new historic low, at an average of 50-55 percent in new loan deals. Leverage varied slightly depending on the lender type.

While senior lenders preferred to stay in the 50-55 percent LTV range, the report noted that 55-58 percent LTV lending is typical across the market. Whole loans advanced by non-bank lenders were recorded as around 75 percent.

The report added that, although there was some capital available for 70–75 percent LTV lending, private equity-based debt funds required minimum returns of 9-11 percent for such high leverage.