Social, demographic and technological disruption is causing a fundamental shift in UK property that is posing challenges, but also offering opportunities, for lenders. That was the overarching message delivered to those gathered for real estate consultancy Savills’ Financing Property presentation, held in London across three days this week.
The annual event, in its 31st year, included Savills’ valuation specialists Ian Malden and Nick Hume sharing feedback from their discussions with UK-based real estate debt providers. A recurring theme was that parts of the country’s property sector are moving towards an operational model, with landlords increasingly entering into management agreements with the businesses occupying their buildings. Although some lenders are keen to follow, others are cautious, citing the lack of transparency from operating entities.
Describing a property sector late into its cycle and undergoing structural changes, Malden and Hume argued that lenders would need to adapt to market conditions. Here are five points raised at the event that we think real estate debt professionals should take note of.
1. There could be stress at the point of refinancing in the coming years: Hume said at the event that around 78 percent of the UK’s outstanding property debt was due for repayment in the next five years, up from the 73 percent reported last year. With the potential for a fall in capital values, it will be challenging to replicate existing levels of leverage if sustainable interest-cover ratios are to be maintained. This might mean borrowers are required to stump up more equity or source subordinated debt, which would create opportunities for non-bank lenders that could offer higher-than-average loan-to-value ratios.
2. Hindsight might show 2017 to be the most secure year for lending: Hume stressed that the UK property lending sector appears well-disciplined, with most senior debt written within 55-60 percent LTV. However, ICRs, LTVs and default rates all crept up slightly in 2018. The lending industry is far more cautious than it was at the height of the last cycle in 2007, but lenders should maintain standards and stay within their risk parameters.
3. Lenders cannot afford to kick the can down the road when the terms for loans on retail properties are breached: Savills reported a reticence among lenders to provide loans for retail assets or even to supply quotes for such facilities. Where they did, margins were up substantially to reflect the reduced credit quality of many retail tenants, as well as structural changes in the sector. Where there are breaches in existing loans, Hume said there was a greater need for lenders to engage with borrowers. This would include reviewing business plans, insisting on curing breaches with injections of equity, or raising loan margins. He added that the number of consensual and non-consensual asset sales was likely to increase.
4. Understanding the equity story is essential: Hume said that those lenders following borrowers into emerging real estate sectors – and especially those in which assets are run by operators, such as build-to-rent residential and serviced offices – prize the quality of the sponsor and its business plan. Understanding an asset’s income stream, cashflow and the measures that can be taken to adapt a business plan if things go wrong should be key considerations for lenders.
5. Shorter leases are becoming a fact of life: As real estate transforms into a service industry, lenders and valuers need to get to grips with sponsors granting greater flexibility to occupiers. According to Mat Oakley, Savills’ head of commercial research, this will mean a greater emphasis on cashflow and hotel-style valuations across property sectors, with the possibility of turnover rents in the retail sector. The flipside, he added, is the growing volume of global capital seeking long-term secure income to fund the pensions of ageing populations. With the availability of such assets diminishing, competition will be huge, and this creates the potential for capital value increases over the coming years.
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