Bayes' semi-annual real estate report shows new lending is down significantly year-on-year
New lending to commercial property fell 33% last year to the lowest level since 2013, according to the latest semi-annual report from Bayes Business School (formerly Cass).
The report, researched and authored by Dr Nicole Lax, Senior Research Fellow at Bayes Business School, City, University of London, also shows that a significant proportion (42%) of the £170 billion in outstanding loans will have to be refinanced within the next 12 months, which Dr Lax predicts will cause ongoing stress in the market.
According to a respected commercial property report, new lending will reach £32 billion, the lowest level since 2013, while total outstanding debt is expected to reach the lowest level since 2017, hitting £170 billion in 2023.
Dr Lux said the decline in outstanding debt was likely due to lenders not replacing repaid debt with new loans at the same pace, which she suggested was due to lower overall transaction volumes in the real estate equity market, as well as valuation uncertainty and inconsistencies in debt transactions.
Other key findings from the report, which covers data up to December 2023, include:
All lender groups were affected by the decline in lending appetite. New lending fell by between 14% (UK banks) and 50% (other non-bank lenders). New development lending totalled £5.8bn, of which just over half (52%) was for residential development lending. However, there was an overall decline in the development lending pipeline, with development lending accounting for just 16% of total new lending. Around 30% of residential development lending is from smaller lenders (balance sheets under £1bn) which may be at high risk of going out of business or merging with larger funds within the next 3-5 years.
Dr Lux reports record and analyze twice a year the latest structural changes taking place in the real estate investment and lending markets.
Dr Lux said: “The UK lending market is becoming increasingly polarised, with borrowers borrowing from either UK banks or bond funds. European banks are finding it increasingly difficult to raise funds due to ECB regulation, the implementation of Basel IV rules* and unfavourable currency movements in funding costs between sterling and euros.”
“The proportion of international banks actively lending to commercial property in the UK market has been declining since 2018. Historically, these banks provided 32-34% of loans but last year this fell to a record low of 25%.”
International factors can complicate the approach to foreign investment
Peter Kosmetatos, chief executive of CRE finance industry body CREFC Europe, said: “This report shows how lenders have weathered an extremely challenging year for CRE in 2023. There is ongoing stress in the UK CRE market but diversified funded lending has broadly continued. The exit of international banks is notable; for many banks, regulatory and commercial challenges in their home jurisdictions may be the deciding factor rather than the conditions in the UK market.”
Aparna Sehgal, partner at Dechert, said: “As always, the results of this report are enlightening and confirm what we know as CRE market participants through our work in this space: Six-month deal activity is up compared to the previous period, and commitments to deal activity are also increasing, but overall deal levels, and in particular the volume of new capital raising, remain subdued. However, data on stabilizing prices (coupled with declining leverage) is encouraging and should lead to increased deal activity.”
“The continued rise in alternative lenders offering capital also reaffirms that the CRE market remains attractive to investors (and indicators outside the scope of this report suggest that the pool of available capital is expanding through back-leverage offerings). Overall, the CRE ecosystem appears poised to respond as more favorable macroeconomic conditions materialize.”
Chris Gaw, head of European treasury and structured debt at CBRE, said: “2023 has been a year in which lenders have sought to prioritise identifying the nature and size of problem loans over new lending. This process is now largely complete and we have seen a strong recovery in lender liquidity so far into 2024. Pricing, leverage and covenant terms have all become more favourable for borrowers across investment lending across all asset classes and development in the most favoured residential, hospitality and data centre sectors, where competition is strongest.”
“Some lenders are more aggressively defending their positions on defaulted loans. Foreclosure rates are increasing but remain very low overall. Combined with the modification and extension strategies that many lenders are employing, we believe the majority of short-term maturities will be resolved with terms greater than 12 months.”
Mid-year recovery?
Ben Thomason, head of UK and EMEA debt advisory at Colliers, said: “The findings from the Bayes report highlight how much the property market has been affected by rising interest rates and their impact on servicing, which has resulted in transaction volumes remaining at unusually low levels last year.”
“In the meantime, we've seen the launch of more bond funds than ever before that can act quickly, are more flexible and have a view on ICR and overall deal packages. However, we expect activity to start to pick up again in the middle of the year as interest rates and inflation start to fall. We've already seen margins shrink to well below 200bps from many of the larger UK banks on strong proposals with low ICR requirements. At the same time, investor confidence in the market is returning as price expectations have calmed after a period of rebalancing over the past year.”
Nick Harris, head of UK and cross-border valuation at Savills, said: “Increased underlying funding costs into 2023 have limited the viability of many commercial property transactions, with falling values across most sectors and limited availability of stock in the market resulting in reduced new loan issuance compared to 12 months ago.”
“The latest Bayes report also shows that lenders are increasingly looking inward, seeking to refinance loans which represent 42% of total lending. Although loan defaults are on the rise, lenders have generally stood by their customer base, especially where there is debt interest coverage. “Extending or restructuring loans has been the preferred option rather than forcing a sale into a weaker market.”
Caution for secondary retail assets and the shopping centre sector
In terms of lending focus by asset type, the report found that fewer than 10 lenders were willing to lend to secondary retail assets or shopping centres. In contrast, 45 and 43 lenders were willing to lend to prime logistics assets and student housing assets respectively, which are the most attractive asset types for lenders.
The good news for borrowers is that average loan prices are remaining broadly stable across property types through 2023. Loans against prime office properties closed at 275 basis points (bps – see below), up 5 bps over the 12-month period, and prices remain competitive at 160-200 bps for prime assets. In terms of alternative asset classes, insurers are offering the most competitive margins for hotel assets (315 bps) and student housing (239 bps). All lenders are offering competitive terms for residential assets.
*About Basel IV – Changes to global capital requirements agreed in 2017 by the Basel Committee as part of the finalization of Basel III. Due to come into force from 2025 under transitional rules. Prohibits banks from using internal risk models to assess the credit risk of large companies with a turnover of at least €500 million (including specialized lending to real estate). It also restricts banks' use of internal models through output floors and amends the leverage ratio, credit valuation adjustment (CVA) and operational risk frameworks. The reforms aim to harmonize the way banks calculate credit risk when determining capital requirements.
**Basis points (BPS) is the industry way of measuring interest rates. For example, an increase of 50bps equates to an increase of 0.5 percentage points.