Eyes turn to alternative lenders after six solid months for UK property finance | New

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Bayes UK’s latest commercial property mid-year 2022 report shows that £23.7bn (€27.2bn) of new loans were issued in the first half of 2022, indicating a strong appetite for new business before deal flow begins to slow after June.

But with the UK entering a radically different interest rate environment, traditional lenders such as banks and building societies should pass on funding opportunities to alternative lenders who can provide mezzanine financing.

The semi-annual report, authored by Nicole Lux, a senior researcher at Bayes Business School (formerly Cass), shows that the alternative lender segment has now seen 12 years of continuous growth, averaging 15% per year.

Lux said: “Interest payments and property income were approaching a 1:1 ratio in June 2022, and with the five-year Sonia swap hitting 5.2% at the end of September 2022, income from property will not be sufficient to refinance some properties at these rates, leaving a potential financing gap.

“Our analysis shows that property net income yields must increase to more than 6% across different property types, or that property values ​​must adjust downward by 25% to 35% to reach a new equilibrium of the market.”

With the announcement of interest rate hikes in January 2022 followed by the onset of the energy crisis following Russia’s invasion of Ukraine, UK government bond issuance fell to a low of 4 billion in the first half of 2022, according to the Bayes Bond Monitor.

The high marginal cost of debt is forcing developers and real estate companies to shift from a debt-financed acquisition model to a small-cap owner/investor model. Some developers consider financing new construction with 100% equity.

Paul Coates, Head of Debt and Structured Finance, CBRE Capital Advisors, said: “The Bayes report continues to demonstrate the diversity and depth of liquidity in the UK lending market, which should provide confidence for the future. . As of the report date, some of the macroeconomic and geopolitical challenges were evident and have accelerated in recent weeks, which the lending market and the broader real estate market are pricing in.

“In the short term, we are seeing a flight to quality, whether it is sponsor strength and/or asset quality, some moderation in leverage to maintain leverage ratios debt service and some margin increases reflecting the broader environment.”

Coates added that in a higher interest rate environment, credit strategies provide a strong risk-adjusted return investment for many institutions.

He said: “We know increased allocations are happening, so I expect we will continue to see lender liquidity available in the market, from all types of lenders, with variations at the micro level, as individual institutions define their own strategy regarding their portfolio and risk/return appetite.

Against this backdrop, Coates expects to see competitive bidding for the strongest deals and the continued trend of lenders’ focus on sustainability, through ESG metrics.

The Bayes report found that UK banks dominated their own market, providing 35% of new funding, followed by debt funds which held a 24% share. Alternative lenders, including debt funds and insurance companies, accounted for 38% of new loans.

Conversely, international banks have seen their market share gradually erode from 34% to 28% over the past 10 years. Overall, according to Bayes, the 12 largest originators were responsible for 58% of new loans, five of which were UK banks.

However, a significant price gap remains between the largest and smallest balance sheet lenders, resulting in a price gap of 0.8% for prime offices. For example, spreads on prime office lending for the largest lenders average 1.98%, while borrowers can expect to pay an average lending spread of 2.77% when ‘they borrow from small lenders.

When asked broadly about lending appetite for 2022, prime office and industrial are the two real estate sectors that most lenders are willing to finance (93% and 85%, respectively), followed by residential investments of first order (81%).

Development loans accounted for 22% of new issuance in 2022, showing a further increase in commercial development finance, which for the first time since the pandemic includes speculative development finance.

Key highlights from the report, which covers data through June 2022, also include:

  • Loan funds undertook larger-scale asset transition projects, providing 72% of business development financing;
  • Spreads for prime office loans squeezed by 5 basis points over six months, showing stiff market competition in the first half of 2022, but, for other property types, spreads for loan-to-value ratios (LTV) of 60% increased by 5 to 10 basis points;
  • In general, smaller lenders have been less likely to refinance existing borrowers and therefore have the lowest customer retention rate, generating most of their business from new acquisition loans;
  • Underperforming and defaulted loans remained stable, with an average default rate of 3%.

Peter Cosmetatos, Managing Director of mortgage lending association CREFC Europe, said: “Economic and political conditions have changed very rapidly since the end of the period covered by this research, but it is valuable to have this detailed picture of the state of the market. to what can prove the end of one era and the beginning of another. It depicts a stable and diversifiedly funded market, with debt funds and insurers together accounting for 38% of new creations and overtaking UK banks and building societies for the first time.

“It remains to be seen whether the market will be as resilient to the consequences of geopolitical turmoil and higher interest rates as they were to Brexit and COVID, and who is best placed to finance the reallocation and decarbonisation that ‘much of the country’s real estate needs.’

Neil Odom-Haslett, President of the Association of Mortgage Lenders, added: “At the start of the year there were already a number of signs that the property market was getting a bit overheated and the Russian invasion of Ukraine has certainly accelerated. this with rising inflation and rising interest rates, to name but two of the headwinds.

“In the first quarter, there was a crossover when the overall cost of debt exceeded the net initial yield on real estate across many asset classes, which generally suggests this cannot be sustained indefinitely (unless in the event of strong rental growth), and that it is likely that there will be a valuation correction at some point in the future.

“The report suggests that a number of lenders continued to lend despite this and just as we were reaching the top of the market (the consensus view is that the valuation peak was in June). However, the report says they have maintained their underwriting discipline (for the most part) with maximum LTVs for senior debt at 60% (so they are unlikely to see the distress of previous cycles).

“I am slightly surprised, however, that there hasn’t been more stress and distress in development lending with cost inflation and supply chain issues – perhaps that will follow in the second half of 2022 and in 2023.”

To read the latest edition of the latest IPE Real Assets magazine, click here.

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