Property Debt: Beyond the boroughs

The story of UK property debt was all about the regions last year. Russell Handy reports on an industry looking firmly beyond London 

Demand for finance in the UK regions last year outstripped that for London.

Increased need for finance from borrowers beyond the UK capital is a sign of the times, with commercial real estate’s main sectors attracting investors in search of less hardened yields.

“The main driver for increased lending in the regions has been the fact that yields in central London are so low,” says Ravi Stickney, partner at Cheyne Capital.

Andrew Radkiewicz, global head of debt strategies at Pramerica Real Estate Investors, says that over the past three years, most regional market opportunities – be they buying, refinancing, repositioning or development – have involved domestic investors rather than global equity, resulting in more use of debt.

“There was a significant increase in interest in the regions last year,” he says. “International capital is now buying outside London and seeking fully-stabilised assets.”

In its CRE Debt Barometer, Laxfield Capital found that 56% of loans made in the third quarter of last year were outside London, where margins are as much as 150 basis points lower.

Acquisition-related financing has increased significantly, with more than 60% of loan requests being for new investment, according to Laxfield’s report. Of a sample of 904 loan requests totalling more than £75bn, the firm found lending activity in all commercial real estate sectors had risen.

Emma Huepfl, co-principal, says finance requests have followed strong investment activity in the regions, “clearly demonstrating belief that the next phase of economic growth is established beyond London”.

Amy Aznar, head of debt and special situations at LaSalle Investment Management, says the firm was “very active” in regional UK lending last year, including Glasgow, Leeds and the West Midlands.

“Over the past year, we have invested over £205m in seven regional UK deals, including investments in logistics, shopping centres and student housing developments,” she says.

UK regional real estate is benefitting from a combination of renewed optimism and heightened levels of competition for assets with London postcodes.

“Given the yields that debt funds seek to achieve, as competition has increased in the London and south-east market and pricing has been driven down among conventional lenders, some alternative lenders have looked for yield in the regions,” says Paul Lyons, partner in law firm Goodwin Procter’s real estate capital markets group. 

Lyons says about 50% to 60% of the UK work that the firm has seen in recent months has “a regional flavour”. 

TH Real Estate head of debt, Christian Janssen, says the firm “likes opportunities where there’s some asset management angle”.

The firm’s UK Enhanced Debt Fund, its first step into the lending sector last year, is focused on value-add, secondary and regional assets. The fund provides whole loans and, selectively, junior loans in the £10m to £100m range.

“Generally, we have lent in or in the vicinity of larger metropolitan areas,” he says. “We need to know there’s liquidity for the underlying asset.”

Large UK cities and conurbations clearly appeal. Radkiewicz says: “Some UK regional cities offer better prospects right now than their continental European peers, when you consider their respective economies.” 

Conversely, Stickney says that in 2015 there was a “weakening” in financing for “tertiary quality” regional assets that require “speculative asset management”.

“The bulk of our deals have been in the south-east regions,” he says, while acknowledging the attraction of the likes of Birmingham and Manchester. “There’s enough to do in that pipeline.”

Conor Downey, a real estate partner in the London office of Paul Hastings, says: “The types of asset that trade are typically very prime and core. There’s a lot of competition for that.” 

Downey says traditional lenders will typically consider financing “large, chunky, almost trophy assets. Those assets tend to be large lot sizes with stable income,” he says.

The reality, Janssen says, is that there are “not that many large assets in the UK regions”.

ICG-Longbow joint head Martin Wheeler says the UK commercial property sector is split into “two market places”. 

The firm, which specialises in mid-market, regional lending, has typically financed domestic, specialised borrowers. “Much of what we have done in the last decade has been repeat business with existing borrowers,” Wheeler says.

The firm deployed some £1bn last year, with an average deal size of about £25m.

“Some UK regional cities offer better prospects right now than their continental European peers”
Andrew Radkiewicz

Smaller investors are more likely to need funding in place before deals complete, he adds. 

While the move by international investors to beyond London’s M25 is palpable, their “safety first” approach is clear. Stickney says borrowers are being driven into the long-lease real estate sector, stressing the importance of lease length and tenant.

Backed by new and existing institutional investors, Cheyne Capital, Stickney says, will not finance “highly speculative assets where the outcome of asset management is unclear”.

Radkiewicz says that Pramerica, which is backed by investors from Europe, North America and the Middle East and focused on the retail, office, residential and logistics sectors, is “comfortable to take leasing or repositioning risk, something banks are less likely to do”.

“The big opportunity for lenders is to provide finance for repositioning to create core regional assets for institutional investors,” he says.

Wheeler says there is sustained demand in the UK regions from borrowers for value-add finance. In central London, investors with a value-add approach are not prepared to pay for an asset’s potential upside upfront, he says.

For now, there is little sign of the UK commercial real estate getting ahead of itself through over-optimistic speculative development, if loan-to-value (LTV) ratios are a fair barometer. De Montfort University found that finance for speculative development, for example, increased last year – but LTV ratios remained around 60-70% among non-traditional lenders. The figure – higher than the 50% offered by their traditional banking and insurance peers – should not give cause for concern. 

New loan boom but no ‘exuberance’

The highest level of new loan originations since 2007 was recorded in the first half of last year, according to De Montfort’s report. The university’s half-year study found £24.7bn of new loan originations. Despite the optimism and increased regional activity, both De Montfort and Laxfield’s reports found that, across all investments, LTV ratios are not creeping up.

De Montfort, which surveyed 49 banks and building societies, 11 insurance companies and  20 other non-bank lenders, said outstanding debt with an LTV ratio of between 71% and 100% fell in the last six months of last year. The figure contracted from 14.3% of the total to 12% at the midway point of last year.

The proportion of loans with a LTV ratio of less than 70% grew in the same period.

Laxfield, meanwhile, also found less demand for high-leverage finance in excess of 70%. 

“Exuberance has come out of the lending market,” Janssen says.

The figures do not, however, suggest there is a brick wall for those seeking more leverage. Non-bank lenders, De Montfort found, are more likely to offer higher senior debt LTV ratios. By the middle of last year, LTVs were, in some cases – notably for prime assets – as high as 80%, compared with 75% at the end of 2014.

Increased regulation on lending has, says Stickney, “pushed investment up the risk curve”, with non-traditional lenders offering leverage at levels that banks are unable to reach.

Janssen says there has “clearly been a retreat of banks over-exposed to commercial real estate loans, including regional debt”.

UK sentiment has improved, aided by the sell-down of legacy assets by Lloyds Bank’s HBOS subsidiary and Ireland’s National Asset Management Agency (NAMA). Late last year, US private equity firm Cerberus paid government-owned UK Asset Resolution £13bn for a portfolio of UK legacy loans and an asset management platform.

“Stress has been reduced on those legacy loan portfolios by returning values,” Janssen says.

De Montfort’s report suggests that the surge in non-traditional lenders may have ended. UK banks and building societies remain the dominant lenders in the market, holding 76% of all loan originations at the halfway point last year.