Lenders are starting to test the waters but views of the outlook for lending remain very mixed, as Lynn Strongin Dodds reports

Economic uncertainty, market volatility and impending regulation continue to hang over the property lending market. Some banks have tentatively stepped back into the picture while new non-traditional players have entered the fray. Equity still dominates and while debt is available it is only allocated for the right deals - prime commercial property on long leases with strong tenants and quality covenants.

Hans Vrensen, global head of research at DTZ, the real estate adviser, adds: "Existing equity investors in a non-prime property financed by a highly leveraged loan that is up for refinancing will find funding difficult for some time. But, that is not the case with low risk, well-located prime office and retail properties. Currently, there is still a lot of nervousness in the overall markets about euro-zone government debt, budget cuts and the sustainability of the economic recovery. However, in our view, these are merely aftershocks after the main economic earthquake.

"As general confidence is restored, I think the property lending market will settle down over the next few months. At the moment though uncertainty in the broader markets is making it difficult for market participants to take decisions and as a result the recovery in volumes might be temporarily halted in the second quarter. However, there remains a lot of capital available for investment into commercial property. Most of the third-party managed funds will need to be invested in the next few years ahead of the expiration of commitment periods."

Barry Osilaja director at Jones Lang LaSalle Corporate Finance in London, says: "We are seeing some banks come back into the market but only for prime assets. For example, in London, investors are looking at the City, Central or the West End. These only account for a small proportion of the UK real estate universe and there is only limited appetite from banks for non-core properties. Lending is a function of activity and we have seen some softening in the past four to six weeks. I think, though, that there might be another flurry in the UK after the summer when the market has had time to assess what kind of impact the budget has had."

Overall, JL L is bullish about this year, predicting that direct commercial real estate transaction volumes could climb by 30% in Europe, the Middle East and North Africa. This is due to a better than expected first quarter, which is traditionally a quieter time for property markets. Volumes jumped 75% to €20bn, in the first three months although they were 15% below the final quarter of 2009. The UK accounted for €7.8bn, or a third, which was at the same level as the previous quarter. Germany, France and Sweden were next in line, each reporting an increase in activity compared with the previous year's volumes.

The main players in lending continue to be the large German banks thanks to the healthy Pfandbriefe market. According to William Newsom, head of valuation at Savills, the major players are Aareal Bank, Deka Bank, Deutsche Bank, Deutsche Pfandbrief Bank, Deutsche Postbank, DG Hyp, Eurohypo, Helaba and West Immo. Other participants include Barclays Bank, HSBC, Nationwide, RBS and Santander.

Global banks are testing the waters although their presence is limited, and the quality of the assets is once more the key. Philip Cropper, executive director, CBRE Real Estate Finance, says: "International banks such as Citi and JP Morgan, as well as fund managers Aviva and M&G, are coming into the market - but their main focus is the prime end of the market. They are looking at long-term rental income with strong tenants. An example of a typical recent deal is the Moor Park Capital acquisition and leaseback of Banc Sabadell's real estate portfolio of €403m.

It included quality assets and was partly financed by equity and a syndication of banks providing senior debt."

Mezzanine providers such as UK-based Longbow Real Estate Capital, Duet Group and M&G as well as Pramerica, the real estate investment and advisory subsidiary of Prudential Financial in the US, and Germany's and West Immo have also been scouting for opportunities. However, as Newsom says: "There has been a lot of talk about it but I have seen few deals. There are several funds that have been established to provide mezzanine finance. According to the recent year-end report by DeMontfort University (DMU), nine organisations that provide senior debt said they were also prepared to consider lending above senior debt level. In my view, the reality is that there are only four or five providers of mezzanine."

Newsom believes that 2010 will continue to be quiet for lending, particularly in the UK. "The DMU research shows that there was only £15.1bn (€18.3bn) of new loans in 2009, which was a 10-year low, down from the £80bn-plus at the peak in 2007. I think these depressed levels will continue over the next couple of years. Another huge issue for property lending is regulations such as Basel II and Basel III, which are increasing the amount of capital a bank must set aside against loan portfolios. The requirements are greatly increased where there are distressed loans."

The other factor particularly is the debt overhang. The DMU study says over £55bn of the UK's commercial property debt is up for refinancing this year, and £50bn of loans is in breach of their financial covenant or in default, three times the 2008 figure. Recent research by Morgan Stanley shows that Lloyds has about £62bn of UK commercial property loans, mostly inherited from its acquisition of HBOS, while RBS has roughly £57bn. By comparison HSBC and Barclays have less than £20bn.

As a result, "banks will have to become more proactive with borrowers and stop their policies of extend and pretend as central bank policy supports will be unwound," says Vrensen. "The eventual introduction of the new Basel III reserve requirements will also mean banks will not want to lend as much as before on riskier assets. This will be the driving force behind the development of non-bank lending channels, such as private equity firms and other institutions. So far, sovereign wealth funds such as The GIC and UK institutions, such as insurance groups, have been the most active."