UK senior debt returns stabilise post-Brexit

Returns from UK senior debt stabilised in the first three months after the Brexit vote according to CBRE, but more volatility is likely in the coming months.

In its latest quarterly UK debt prospects report, the firm said its forecast for annualised gross returns from five-year lending in the third quarter 2016 was 3.1 percent, unchanged from Q2 2016.

Dominic Smith, head of real estate debt analytics and the report’s author, said that loan margins rose by 25 basis points in the days following the referendum vote, then quickly stabilised, “reflecting in many ways a quicker return to normality than was thought likely three months ago.”

The 25bps margin rise was reflected in the Q2 2016 forecast.

Real estate debt also continues to compare favourably with other asset classes. The premium over gilts in Q3 2016 widened from 2.7 percent to 2.8 percent and over corporate debt to 1.8 percent.

However, the firm expects the resilience of investors’ risk appetite for the asset class “to be tested further as the realities of a Brexit become clearer over the coming months,” Smith said.

In the last two weeks since the report was compiled, sterling has fallen in value and five-year swaps and gilts have gone up.

During the Q3 period of the latest UK debt prospects report, there was little change in the five-year swap rate with a very slight fall of 6bps. Meanwhile a very small improvement in CBRE’s Q3 forecast for capital growth compared to Q2 resulted in a very slight decline in the probability of default and expected loss. This meant that Q3 forecasted returns on a risk-adjusted basis also stayed stable, at 2.8 percent and also exactly the same as the forecast in Q2 2016.

Smith argues that real estate debt is currently a more attractive investment than London offices taking account of the risk-return profiles.  CBRE’s forecast for equity returns from London offices is only a 0.5 percent premium over debt.

“What is particularly interesting is the rising popularity of real estate debt as an asset class. CRE debt has for some time comfortably offered a premium of more than two per cent over gilts but the scale of improvement relative to corporate bonds is significant.

“Furthermore, real estate debt, thanks to historic low volatility, currently offers very attractive risk-adjusted returns relative to equity exposure, particularly in key markets such as London offices. Indeed, CRE debt is arguably the most attractive form of exposure to the market in the current climate.”