Banks Still Want To Lend, But Not To Retail: Everything You Need To Know About Debt Late In The Cycle

Two significant lending reports were released in the space of a week, which paint a detailed picture of leverage in the UK real estate sector 10 years after it reached a trough in March 2009.

In many respects, the Cass Commercial Property Lending report and the Laxfield UK CRE Debt Barometer, both of which cover the period to the end of 2018, tell a similar story: Lending to commercial property has become more cautious as the macro picture becomes more uncertain, but banks are still willing to lend to the sector. Retail owners will be squeezed by a retreat by lenders, and lending in London is receding.

Ahead of Bisnow London's Capital Markets Review on 21 May, here are eight key findings from the two reports.

Loan origination is up but UK property’s loan book got smaller

Just shy of £50B was lent to UK property in 2018, up 12% on 2017, according to Cass. That figure takes in lending for new deals and refinancing. That showed the continued appetite for the sector, according to the report’s author, Nicole Lux. The report surveys the majority of banks that lend to UK property about their loan books. Despite the increased activity, the overall amount of debt secured against UK property fell from £199B to £195B, as lenders continued the deleveraging process that started during the financial crisis.

Banks are not driving this increase

According to Cass, the biggest part of this increase came from non-bank lenders, with insurance companies increasing loan origination by 21% to £5.1B and other non-bank lenders like debt funds increasing origination by 26% to £7.6B. Both groups now lend more to UK property than German banks, typically the second-biggest type of lender. UK banks still lent the most, at £21.9B, but that was flat compared to 2017, as tighter regulation moderates bank appetite for property lending.

Pricing is somewhat up

While the Cass report showed that pricing for loans secured against prime property were broadly flat, for secondary property these margins increased. Laxfield, which generates data by analysing the requests for loans received by the debt funds it manages, saw pricing increase for loans across all types of property, albeit only slightly.

Is the level of lending an indicator of an overheating market?

In her analysis of the data for Cass, Lux made an interesting analysis. Loan origination levels normally lag overall deal volumes by about a year, and normally the number of loans originated is about half of the transaction volume. Last year, with £54B of deals, the ratio between loans and debt was close to 1:1, the same level as the run-up to the last crash. That could mean two things. Either the market is overheating, or the relationship has inversed for a period, and next year transactions will jump again.

Retail: The withdrawal continues

Lenders continue to shun the troubled retail sector. The proportion of debt secured against UK retail assets has fallen from 26% in 2007 to just 15% in 2018. That is a drop from £55B to £25B, or about £2.5B a year, as lenders choose not to refinance existing loans or extend new ones.

“It remains to be seen how investors and lenders can work their way through a very challenging situation,” said Peter Cosmetatos, Commercial Real Estate Finance Council Europe's chief executive.  

Laxfield gives further insight into the impacts. The margin on retail loans spiked by 20% from 326 basis points to 397 basis in 2018, as lenders put up prices to account for an increase in risk. In the same period, the loan-to-value ratio borrowers asked for rose from 60% to 65%.

“Sponsors appear to be seeking more support from lenders to replace existing funding against deteriorating values and finance acquisitions,” Laxfield said.

The problem is they won’t get that support, as asking for higher LTVs at a time when values are falling does not make sense for lenders. Laxfield said retail has moved from a core asset class to a specialist, niche one, a huge change in perception. 

Defaults are rising

Largely as a result of the problems in the retail sector, loan defaults ticked up in 2018, according to Cass. About 3% of loans were in default, compared to the long-term average of 1%, albeit this is far below the 25% reached in 2009.

Build-to-rent lending is surprisingly moribund

The build-to-rent sector has been one of the most resilient in the UK over the past couple of years, with record investment volumes in the first quarter of 2019. But that has largely been supported by equity investment rather than debt, Cass’ report showed. Just £2.3B of the £19B of development finance in the UK relates to rented residential, a muted level compared to last year.

“Clearly, regulatory and commercial barriers remain that really need to be overcome to maximise the contribution of build-to-rent in addressing the UK’s housing shortfall," said Ion Fletcher, British Property Federation director of finance and commercial policy.

Requests in London are down

Laxfield reported a shift in the balance between London and the rest of the UK, mainly due to the perception that London would be hit harder by any negative impacts from Brexit compared to the rest of the UK. In 2017, 51% of the loan requests received by Laxfield were in London, a figure which dropped to 42% in 2018.

Property lending remains good value for lenders

When all is said and done, lenders are likely to remain keen on debt secured against high-quality commercial property because it offers good value. The yield to maturity on a five-year property loan is 3.2%, compared to 0.9% on a five-year gilt and 2.2% on a BBB-rated corporate loan, Cass said. This makes it attractive to pension funds and insurance companies in particular.

For everything you need to know about the UK debt market, come to Bisnow's Capital Markets Review on 21 May.