De Montfort report shows talk of recovery in the UK commercial real estate finance market is not all hot air.
Are we in the midst of another commercial property credit boom? Given that the slightly fuzzy, champagne-addled memory of the last boom has barely receded, it seems bizarre to have to be asking this question.
But investment volumes at their highest since 2007 and regional yields hitting record lows have caused some in the market to ask whether property has rebounded too far too fast, and, inevitably given the nature of the last cycle, questioned whether the bad old days of too loose lending are back.
With term sheets on loans at 90%+ loan-to-value (LTV) ratios back on the agenda — such as the £95m loan provided by Blackstone to fund the £105m purchase of Old Spitalfields market last July — it is not hard to see why.
However, it would seem that if the market is overheating, this time around, it is not as a result of too much credit. The definitive annual De Montfort University report into the state of commercial property lending was revealed this week, and it paints a picture of a cautious and sustainable recovery in lending levels, which put the market on a sustainable footing.
In fact, a report that for the past six years has made unremittingly miserable reading for the industry shows that 2013 was a seismic year for property lending, and therefore the sector as a whole. Total debt was reduced as lenders shed legacy loans, the number of problem loans was slashed, new lending was up — but not by too much — there was a broader base of lenders to property, and appetite was starting to emerge for speculative development lending.
Chris Holmes, head of UK debt at JLL Corporate Finance, one of the report’s sponsors, says: “It is pleasing that the UK CRE financing market reached the crossover in 2013 where balance sheets became materially cleansed of legacy positions, lowering overall credit risk. At the same time, resurgent and new sources of debt brought an equilibrium to the borrower/lender equation after years of drought.”
Liz Peace, chief executive of the British Property Federation, says: “There has been a general feeling of improving credit availability in the past 12 months and this year’s report bears that out in figures. Recovery post-crash has been slow but steady, and it is promising to see that the market is now moving in the right direction.
“The banks seem to have significantly patched up their balance sheets and problem loans are being resolved, freeing up capital for new lending. We are also delighted to see that non-bank lenders are becoming a significant part of the market, suggesting that we are moving towards a more balanced provision of real estate debt in the UK.”
Lenders to UK property have been reducing their exposure to the sector since 2008 (see Fig. 1, above) — and 2013 was no exception. The report estimates that there was about £237bn of debt held against UK commercial property — 8.3% less than at the end of 2012 and a drop of about a quarter since the peak of 2008.
The fall shows that banks were more willing to take action on problematic legacy loans, which was because the market for secondary and tertiary property has improved, the report concludes.
Of the reduction, 30% was a result of customers repaying loans at maturity (See Fig 2, below), compared with 38% in 2012, while 29% was a result of customers paying down debt before maturity and “consensual” sales imposed by banks — two things that the report concludes were interchangeable. Combined with a jump in reductions due to loan sales from 8% to 16%, the report paints a picture of banks finally having the confidence to take action and free themselves from problem loans.
Bill Maxted, the De Montfort academic who authored the report, says: “The reduction in legacy positions is partly a result of the sharp increase in liquidity in the market in the second half of the year, which led to capital values increasing. Also, five or six years on from the crash, banks had generally provided accurately for loan losses. Coupled with the increased regulatory burden of holding distressed loans, and banks started to be a bit more ruthless with borrowers.”
New comfort zone
This has fed through to a sharp rise in the quality of the loan books held by lenders to UK property, and it is in this sense that property lenders can be said to have freed themselves from the legacy of the boom.
The report reveals 63% of the outstanding debt held by banks had a LTV ratio of 70% or less, a remarkable increase from 2012, when the figure was 53% (see Fig. 3,below). And lenders reported that 50% of their loan books are held against prime property, compared with 4% last year.
Further down the quality scale, 18% of the outstanding debt had a LTV ratio of between 71% and 100%, compared with 24% in 2012; and 19% had a LTV ratio of 101% or more, compared with 23% in 2012. This equates to £28bn between 71% and 100%, and £31bn above 101%. This means that there is still around £60bn of property debt that is outside the range at which banks would feel comfortable. But given the newly emboldened stance that banks are taking, this is proving less of a hindrance on new business.
In terms of new lending, £29.9bn of new loans were completed, up from £25.5bn in 2012. This 17% rise is the biggest since before the crash. On top of this, banks extended the maturity of £6.5bn of loans that were scheduled for repayment during the year.
It is in this figure that the idea of a sustainable recovery could potentially lie — an increase, but not excessive, and still well below the market peak. While volumes and values are approaching 2007 levels, this is not being fuelled by debt — to put the new lending figure in context, in 2007 more than £80bn of new loans were underwritten.
However, Maxted sounds a note of caution. “We thought there would be a bigger increase in the numbers, but you might see that come through in the next half-yearly report, as liquidity really picked up in the second half of last year, and anecdotally that has continued.
“Lenders are reporting to us that you haven’t seen it coming through in an increase in LTVs, but you are seeing competition on margins.”
Lenders’ intentions for the future also paint a positive picture. Of those surveyed, 62% said they intended to increase the value of their loan originations, compared with 54% at the end of 2012. And 60% said they intend to boost the size of their loan book, compared with 46% previously.
Development should also see an uptick in funding in 2014. The same number of lenders (14) said they would lend on fully prelet commercial development at the end of 2013 compared with 2012; nine said they would lend at 50% prelet, compared with seven in 2012; and four said they would lend on speculative development, compared with none previously.
The confidence flowing through debt markets and the likelihood of a stable recovery is borne out by a second report released today, the Laxfield Capital UK Commercial Real Estate Debt Barometer, which tracks enquiries for debt from UK borrowers.
It showed that, while at the end of 2013, 85% of the pipeline of requests from borrowers were to refinance existing loans, that has dropped to 45%, with 55% looking for debt to finance fresh acquisitions.
“There is real evidence of the market rebounding, and the debt overhang issue is solving itself,” Emma Huepfl, co-founder and head of capital management at Laxfield, says.
As further signs of confidence Huepfl points to the fact that 58% of loan requests were in the UK regions, and previously moribund sectors like retail were now recovering, and made up 44% of financing requests, double the level in the first three quarters of 2013.
In terms of the risk appetite of borrowers, there is a sharp uptick, but not to a level that is worrying - yet. The average LTV being sought by borrowers was 58%, up from 52% at the end of the third quarter of 2013. Huepfl breaks this down into conservative companies like REITs that are remaining cautious, and borrowers starting to move up the risk curve. 56% of borrowers are looking to borrow at 65% or less, 21% at more than 65%, and 23% at more than 70%.
“As the market improves, borrowers are having to take on more debt to meet their return expectations,” she says.
A further cause for celebration from both reports is the broadening of the type of lender active in the UK market. Non-bank lenders accounted for 23% of the market, up from 15% in 2012 (see Fig. 4, above). Of this, 12% came from non-bank lenders such as debt funds, up from 5% last year, while insurance companies provided 11%, a rise from 10% last year. Maxted reports the loan book of debt funds increased from £2bn to £6bn — still small, but a sharp increase.
The decrease in the concentration of lending was also shown by the fact that the top 12 lenders undertook 63% of new loans, compared to 72% in 2012. This diversification has long been desired in the UK — one of the reasons consistently cited for the slow recovery of the UK property lending market is concentration of lending in the hands of banks, which have typically made up more than 90% of the market, compared to around 50% in the US.
“Borrowers now have the genuine choice of lending partners at every part of the risk/reward spectrum and across all asset class,” Holmes says.
Huepfl adds: “If you are an investor looking to come to the UK and buy direct assets, you can pretty easily come up with a list of assets that fit your criteria,” she says.
“With debt it is more difficult — you need relationships with borrowers, and it is a more complicated process. But there are different types of investors looking at different parts of the market, and there is appetite to lend at every level at which borrowers are operating.”
Everything is pointing the right way for the UK debt markets. Seven years after their peak, and five years after the market nadir, the legacy is being shifted, allowing new lending to be undertaken at reasonable levels. Such conditions never endure for long, but for now, debt is no longer in the limelight as property’s biggest cause for concern.