UK lending volumes have rebounded to £50 bn, the level of the last peak says the latest, 2021 Bayes UK Commercial Real Estate report.
New lending volume in 2021 reached almost £50 bn (£49.8 bn) which is 48% higher than 2020, more than 2019 and the strongest year since 2015.
However, margins also jumped last year and recent interest rate increases of UK 5-year swap rates have added to the cost of new lending, and will put pressure on income coverage ratios on some loans.
Dr Nicole Lux, senior research fellow at Bayes Business School (formerly Cass) and the report’s author, said she was surprised by the strength of the market last year.
She said it appears that during the first half of 2021, a backlog of 2020 transactions due to Covid was being resolved while the second half focused on more new acquisition financing for existing and new borrowers.
‘In the first half of 2021 borrowers were looking to finalise, restructure and refinance loans that had been on hold during 2020. For the whole year, this accounted for 52% of lending while the other 48% was for new acquisitions.’
In addition she said: ‘Everyone has been focusing on finding large deals and the average size went up (to £59 mln). ‘Even for non-bank lenders it has really quite increased.’
Margins rising
Average margins for prime office financing rose from 2.29% at 2020 year end to 2.54% in 2021. Although the average masks the variations between terms offered by different lender types and for different LTVs, the direction of travel has been clear, Lux said.
Margins increased most for debt funds (by 66 bps), while UK banks raised margins by an average 34 bps and international banks by 25 bps.
Insurance companies actually lowered margins by 15 bps but also lowered LTVs from 58% in 2020 to 56%. German banks’ margins are the lowest but they have been less active in the UK.
On a 60% LTV basis, margins jumped from 218 bps in 2020 to 242 bps in 2021.
‘If you’re a lender in the very prime segment there’s always a lot of competition so you don’t really get to the point of increasing your margins that much’, she said. ‘But if you look at the overall market, since 2015 the tendency has been upwards.
‘By the end of 2021 lenders were already pricing in the interest rate increase that happened in January. This was already priced into the five-year fixed rate’. The 5-year Sonia swap has increased this year to 1.86%, leading to an overall interest rate on loans of 4.4% for some properties - close to prime office yields.
‘She added: ‘And that’s why a lot of the debt funds told us in January, when we did the interviews for the report, that margins went up another 1%. If they were expecting an IRR of 6% before, it’s now 7%.’
Another issue in 2022 flagged by UK banks - a group which still took almost 40% of the market in 2021 - is that they expect managing their balance sheets to get harder.
One reason is that borrowers with floating rate loans have been asking to switch and fix their rates. But Lux suggested: ‘it’s already too late to realise they have to do something, because the long-term rates have already increased. Banks now have to manage the balance sheet between all the facilities (and say) it is going to be a lot more complicated.’
The challenge of ESG
The other challenge for bank lenders is ESG. Only about half the 76 lenders surveyed (54%) replied to questions about their policies. Of these, 58% said they would allow for lower margins for properties with high ESG standards (an increase from 43% six months previously).
‘There are so many issues and how do you price the loan if you don’t even know what the cost of getting an existing building up to standard will be and how the building will be priced when it’s all done?’, Lux pointed out. ‘So they feel they have to be really careful with their decisions and also how and on what they use their balance sheet.’
UK banks have slotting, ‘and it’s now not clear how that’s all going to work.’
CBRE IM said last month in a report called The role of credit in transforming European real estate that the cost of upgrading an office from an EPC rating of F or G to B or C has been estimated by PMA at circa €200 and €300 per m2 - far more than the cost of standard maintenance.
Debt funds the beneficiaries
Debt funds may be the beneficiaries. Lux pointed out that they raise specific buckets from investors for certain strategies to deliver a type of return and risk profile. ‘They have a clear message and profile while if a borrower goes to a bank they just don’t know their process or if they look at this type of asset.’
Non bank lenders continued to increase their share of the UK lending market in 2021, from a quarter to a third.
All lenders still have breaches and defaults outstanding across their books, but they have ‘remarkably’ resolved their problem loans, the report says, and the weighted average default has declined from 4.6% in 2020 to 2.9% in 2021.
Commenting on the report, Peter Cosmetatos, chief executive of CREFC Europe, said: ‘Two questions for the future are will the market be as resilient to the consequences of geopolitical turmoil and inflation as they were to Brexit and Covid?
‘And who is best placed to finance the repurposing and decarbonisation that so much of the nation’s real estate needs?’
Lenders believe credit availability will tighten
At an event for lenders and sponsors to launch the report, held on the evening of 4 May in London, 67% of the audience said rising interest rates and a possible recession would be the most important issues in the coming period with another 18% naming inflation. Nobody named a possible resurgence of Covid as the most pressing issue.
58% said rising property yields would have the biggest negative impact on property returns while 63% said credit availability will tighten.
