UK Distress Dries Up, New Lending Set To Increase As New Players Enter The Market

Investors looking for distressed deals coming from lenders in the UK and Europe might well be disappointed this cycle. 

Although real estate values have dropped and refinancing can be a challenge, lenders are mostly choosing not to pull the plug, according to one of the largest loan servicers in the market. 

“We haven’t seen much distress,” Mount Street Global Chief Operating Officer Serenity Morley said. “The only distress we have seen is where you might have the wrong asset in the wrong location or a sponsor that isn’t engaged.”

Mount Street provides underwriting and loan servicing for lenders in the UK, Europe and, more recently, the U.S., where it has established a regional head office in Atlanta.

After a difficult two years for borrowers and lenders in which rising interest rates caused falling asset values, investment volumes and new debt issuance, debt markets are ready for a rebound, Morley said. 

As values stabilise and rates start to come down, refinancing is becoming easier for borrowers and lenders alike. And new lenders like challenger banks and an ever-growing number of debt funds are entering the market, providing an increasing pool of liquidity. 

“We think the UK market has bottomed out,” Morley said, adding that could be beneficial in helping work through distress while precipitating growth in new lending.

On the distress side, data indicates that the last two years have been tough for lenders. But the wave of problem loans that many anticipated when interest rates rose by 5% in the space of a year has not materialised. 

Some £3.7B of loans were in default and a further £3.6B in breach, according to the Bayes Business School’s Mid-Year 2024 Commercial Real Estate Lending Report.

That default figure equates to 4.9% of all outstanding UK real estate loans — up from 4% at the end of 2023 but still well short of the 2010 peak, when 25% of loans were in default.

Morley said that loan-to-value covenant breaches are more common than interest cover covenant breaches or debt servicing covenant breaches, which come about when there is not enough income from properties to comfortably cover interest payments. Even at the peak of new debt issuance in 2019, loan underwriting was still relatively conservative, and loans were only issued when there was significant income available to cover interest payments.

The scale of problem loans in the wake of the 2008 financial crisis meant lenders had to put in place the infrastructure to deal with distressed loans. This time around, the scale of the problem is more manageable, and a different strategy is being taken.

“Lenders are more solutions-focused and don’t want to enforce,” Morley said. “They don’t have large teams to enforce and don’t want to crystallise losses.” 

Morley said distress was more typically occurring in debt funds that have come to the end of their fixed-life term, which squares with the Bayes data. While only around 3% of loans underwritten by banks are in default, that figure climbs to 14% for debt funds. 

For new lending, the volume of loans underwritten in the UK fell 9% year-on-year in the first half of 2024 to £16.7B, according to Bayes data. With investment volumes down, so is debt for new acquisitions.

However, some of the lenders with whom Mount Street works reported missing out on deals because the interest rate margins they were offering were too high. That is an indication of increasing competition among lenders, Morley said.

Nonbank lenders, including debt funds and insurance companies, now make up more than 40% of all debt outstanding in UK real estate, a huge change over the past 15 years. Morley said there is continuing interest from new funds entering the market, many of which need outside debt servicing capabilities. 

Debt funds accounted for about 40% of all equity raised by funds targeting European real estate in 2023, a research report from investment manager DWS says. The firm singled out whole-loan strategies — those in which lenders provide senior and junior debt for deals — as offering the best balance between risk and reward in European real estate for the next few years.

Morley added that smaller “challenger” banks were increasingly clubbing together to provide larger loans. If three banks provide £5M each, they can provide a combined £15M and lend on better-quality properties, or so the theory goes. 

The next big push for Mount Street is the U.S. Having started in the UK and then expanding to continental Europe, it has now set up offices in Atlanta, Kansas City, Kansas, Dallas and New York. Mount Street is looking to compete with established giants like Situs, CBRE and Trimont by providing what Morley said is a more European offer.

“What we find over there is that the mainstream servicers are a bit behind on the service levels they provide,” she said. “We think we can bring a more European focus to the market.”