UK margins increased by 40bps in 2016, says CBRE

UK commercial real estate loan margins increased by around 40 basis points across the whole of 2016, with the bulk of the movement in the final week of June after the country’s EU referendum, according to new research released by CBRE.

Despite the increase across the year, margins remained flat during Q4 2016 – the second successive month of static margins – the firm’s UK Debt Prospects report for Q4 2016 showed.

Senior debt originated during Q4 2016 offers a forecast return of 3.4 percent per year on a gross basis and 3.1 percent on a risk-adjusted basis, almost a 40 basis points increase on Q3 returns. CRE debt remains attractive when compared to fixed income, CBRE said, with senior CRE lending offering a premium of 2.6 percent per year to the risk-free rate, on a risk-adjusted basis.

“Just as noteworthy perhaps – and increasingly an important driver of allocation from fixed income investors – is the scale of return relative to corporate bonds. We estimate that the gap in gross returns to CRE debt investors and corporate bond investors stands at 1.8 percent in Q4 2016,” the report added.

Five-year swap rates increased by 37 percent during the fourth quarter, ending 2016 at 72 basis points lower than at the end of 2015.

The key measure for banks, return on risk-weighted assets was flat. On a RoRWA basis, gross returns were 3.5 percent and risk-adjusted returns were 2.9 percent per year, assuming ‘strong’ slotting treatment.

Mezzanine returns were estimated to be 8 percent per year on a gross basis and 5.4 percent per year on a risk-adjusted basis at the end of Q4, a rise on Q3 2016 caused by lower expected loss as a result of a stronger outlook for underlying capital values.

A modest improvement in the forecast for capital growth resulted in a slight decline in probability of default and expected loss over Q4. The forecast for the five years to Q4 2021 is for an aggregate rise in property values of 4.3 percent, reflecting a further improvement in capital growth outlook, compared to the forecast five-year growth of 0.3 percent in June and 2.8 percent in September.

CBRE estimates that Q4 2016 senior, 65 percent LTV originations have a probability of default of 2 percent and annualised expected loss of 0.3 percent. There is, however, significant variation at the segment level, ranging from zero percent probability in retail warehouses to as high as 5.4 percent in London offices.

CBRE also analysed the historic relationship between investment and development finance terms. “Over the long-term it seems that development lending could offer superior risk-adjusted returns to investment lending. With many players currently excluded from this market – via regulatory constraints in the case of traditional bank lenders or Mandate limitations in the case of newer lenders – the shortage of development finance may be set to continue. This would be a missed opportunity for lenders, borrowers and the wider economy alike, arguably representing a significant market failure.”