The UK Doesn't Have America's Real Estate Banking Crisis. It's Got Its Own Problems Instead

A harsh spotlight has been turned on the commercial real estate loan books of U.S. regional banks in the past fortnight. The question now for UK real estate is, will the same problems be repeated here, or manage to cross the Atlantic?

The take-under at Credit Suisse, following the collapse of Silicon Valley Bank, and uncertainties about the future of a clutch of U.S. regional lenders are, together, bound to spook markets. Bad memories of the Great Financial Crisis of 2008 are haunting property lenders and borrowers, and the apparently outsize commercial debt loan book is the focus of much anxiety. 

If you believe a widely reported Goldman Sachs assertion that 80% of $2.6T of U.S. commercial real estate lending is with smaller, thus more vulnerable, regional banks, then on the face of it there's grounds for concern. Banking contagion could tip the UK and Europe into similar problems is the bearish view.

Whatever is going on in the U.S., the risk of a homegrown property lending crisis in the UK is modest, and the dangers of contagion are small, experts interviewed by Bisnow said. Better still, the UK regulatory system simply makes an SVB or Credit Suisse crisis impossible, officials insisted earlier this week in an appearance before a House of Commons committee.

Yet this comforting message comes with a big reservation, according to Bisnow's sources. First, landlords should expect some pain and equity should expect to take losses. For some of those whose loans were based on aggressive pre-2022 valuations, it could be curtains.

The obvious place to begin is with the data, and with observers who can take a bird's-eye view. The hope is that from way up high today's confusing picture might make more sense.

Last week the City of London’s Bayes Business School and Oxford Economics suggested places to start looking.

Oxford Economics pointed to nonbank alternative lenders. It noted that “much of the lending falls outside of regulatory oversight, so the risks are much more opaque”.

“Recent bank funding turmoil will lead to additional tightening in credit conditions for commercial real estate at a time when the asset class is already reeling from higher debt costs, an inadequate risk premium, and emerging refinancing distress," Oxford Economics said in a report on the sector last month. "This has prompted us to downgrade our baseline forecast for UK CRE values over 2023-2024."

Academics at business school Bayes looked at European bank lending and concluded that German lenders might be a potential source of stress in the UK and European lending market.

“German bank lenders still offer some of the highest LTV for investment assets (between 75% and 80%) and loan-to-cost for development lending (between 77% and 82%)," Bayes said. "Other European bank lenders have been more conservative (between 55% and 60% LTV and 60% and 75% LTC).”

The implication is some of these loans are likely to be underwater if valuations are under pressure.

Alongside German banks, another area to watch is debt funds and nonbank lenders.

Data suggests both sectors are relatively small, and certainly not dominant. Bayes' data provided to Bisnow said that German lenders accounted for close to 9% of UK commercial property loan volumes at the end of 2021. Nonbank lenders (excluding insurers) accounted for close to 20%. Both have grown since 2015 as UK banks have retreated from commercial property lending, but German lenders have climbed just 6%. Not so for nonbank alternative lenders, whose volumes are up 96% over the same period.

“There is limited exposure to foreign banks, but exposure to alternative lenders, specifically debt funds, has been growing," Bayes Project Director for Real Estate Lending Research Nicole Lux told Bisnow. "They are investment companies, without balance sheets, hence they may not be in the position to wait for borrowers to delay loan repayments, and so on, like a bank could.”

Projected Anxieties

One of those pondering the Bayes' data is Peter Cosmetatos, CEO at CREFC Europe, the trade association for real estate lenders and the real estate finance market in Europe.

Cosmetatos suggested the risks raised by German lenders and alternative lenders should not be overstated.

“It's difficult for me to comment on German regional lenders and their vulnerability,” he said, disclaiming special knowledge, and pointing to their small part in UK lending. “But if they had vulnerabilities, it's probably in their own German markets, not what they are doing internationally.”

Alternative lending is a potentially more significant area of concern, but even here Cosmetatos — usually a notorious bear, he says — suggested reasons to be relatively cheerful.

“Yes, nonbank lending to property is likely to be more in the value-add and higher-leveraged end of the business, so exposed to greater risk and vulnerabilities, so theoretically yes there's an issue," he said.

But the bigger picture in the UK is how diversified the property funding market has become, he went on. It has roughly one-third each with domestic banks, international lenders and nonbank lending, and there is quite a lot of diversity within each of those sectors.

“So we've a range of capital sources and regulatory frameworks, plus pretty sensible levels of leverage before the current inflationary spiral began," Cosmetatos said. "An LTV of 65% was considered high, but it is nowhere near the levels of 2008. So I'd say we have quite a long way to go before lenders hit trouble.”

All of which raises the possibility that the heightened interest in banking stability is a proxy — or kind of Freudian projection — of anxieties about something else. That something could be the extent to which property values in some sectors have collapsed, leaving some borrowers underwater and facing losses, Cosmetatos said.

“We have a way to go before lenders hit trouble, but commercial real estate does need more capital — there is a growing valuation gap," he said. "The good news is there is plenty available but equity will take the pain, which is where it should be in property. But lenders' losses should be limited, I struggle to see much vulnerability.

“There will be a process of pain for leveraged assets, but this is a story of stress for the owners of real estate, not so much for the lenders. Now that could be different in the U.S. There it is unclear how much property debt the regional banks have — I've seen claims that it's 80%, 30% and 12% — and it raises the question, why doesn't the market know how much?”

Cosmetatos pointed out that he was among the authors of post-2008 recommendations on property lending, almost all of which have been ignored. The lending market is more diverse, but it isn't much more transparent, which leaves him baffled and surprised.

This week brought news that a clutch of high-value London CRE assets were, or could be, in over their heads. Among them is the 527K SF 20 Canada Square in Canary Wharf, owned by Hong Kong firm Cheung Kei. JLL has been appointed to sell the building at a guide price of £250M, Bloomberg reported, and has a £265M loan secured against it. The loan was provided by Lloyds Banking Group and matured in October but was not repaid, Bloomberg said.

An Opportunity Not A Crisis?

What do nonbank alternative lenders make of this diagnosis? Precede Capital Partners' co-founder and CEO Randeesh Sandhu sees banking sector turmoil as an opportunity, not a threat.

"The current market turbulence we’re witnessing may result in credit tightening and therefore reduced bank appetite for real estate lending," he told Bisnow. “Nonbank lenders emerged and have grown since 2008, when the banks retracted from lending due to both the financial crisis and the resulting new regulation. The current crisis is very different, and we shouldn’t expect the same outcomes, though it does highlight the importance of a diversified finance market with a number of bank and nonbank participants.

"I imagine banks will have to scale back their lending due to interest cover ratios being harder to meet in the current interest rate environment. Nonbank lenders are recognised as a reliable and attractive alternative, and I expect our share of the market will continue to grow year-on-year, as the Bayes Commercial Lending Report has shown for 12 consecutive years,” he added.

Asked to rate the risk of serious trouble on a scale of one (nothing) to 10 (disaster), RSM UK Restructuring Advisory partner Damian Webb offered a six or seven. “This is not trivial,” he said, adding another category of lender to the watchlist.

“The lenders we need to watch are the bridging and development lenders, and the newer banks, not the bigger banks unless they are exposed through their wholesale operations."

The problem isn't so much now as the next six-18 months, when loans begin to fall in and can't be refinanced that to interest rates and construction costs and the quite aggressive valuations that were originally agreed, Webb said.

"Some lenders will be sluiced, and its not so much the LTV that's the issue, it's the valuations. At the top end they could collapse and that will hit loan covenants on LTV ratios."