Property Lending Enters a New Downward Cycle, With Further Distress Expected in 2021

UK Commercial Real Estate Mid-Year Report reveals sharp market slowdown and higher lending costs for the second consecutive period.

The Business School (formerly Cass) UK Commercial Real Estate Report: Mid-Year 2020 shows a steep decline in lending for the first half of 2020, with a year-on-year decline of 34 percent of new loan origination from the same period in 2019 as the coronavirus pandemic took its early toll.

Findings from the report, covering data up to June 2020 reveal:

• New loan origination in second consecutive period of decline of £15.5 billion, a 34 percent year-on-year downturn from the first half of 2019.
• Margins across all property types rose by 20 – 50 basis points.
  
• New loan to values (LTVs) reached a new historic low with an average of between 50 and 55 percent.
  
• Larger lenders are getting larger, while the smaller lenders continue to struggle. 
  

The first half of 2020 showed considerable dislocation of lending markets. While the lockdown has slowed down lending activity in general, the real dislocation becomes visible in the type of loans that are being agreed. With a lack of large investment transactions, only 14 lenders have written loans larger than £100 million.

While some lenders are actively looking for new opportunities, others are only considering business from their existing borrower base. A total of 22 percent of lenders have not done any lending in the first half of 2020. 

Most lenders are no longer lending to retail assets – particularly to shopping centres. However, outstanding loan amounts allocated to retail assets have remained the same, as lenders choose to extend existing loans that could not be repaid or refinanced elsewhere. Overall, seven surveyed lenders were still willing to consider secondary retail assets when looking at new financing requests.

Due to the growing perception that residential – especially the private rented sector – has strong defensive characteristics, investments attracted the most financing in 2020 at 29 percent. This was a trend observed amongst all groups of lenders, with the second most popular asset class being offices with a share of 24 percent of new loans. 

Author of the report, Dr Nicole Lux, Senior Research Fellow at The Business School (formerly Cass), said: 

“Over the next two years we estimate that £9.5 billion of retail assets and a further £13.5 billion of alternative assets like student housing, hotels and care homes need to be refinanced. Many facilities will be at 85 – 120 percent LTV at that time.

“The short-term effects of the coronavirus pandemic have only just become visible, but the long-term effects will impact lending and banking into next year and beyond. 

“With significantly lower leverage levels and better bank capitalization compared to the global financial crisis, distressed loan sales and receiverships are still a long way off. However, the real estate debt cycle has entered a new phase.

“Despite the regulatory curb on loan books, they have been expanding steadily and are 13 percent higher in 2020 than in 2017. Loan origination displayed the third lowest six-month period since 2010, and the development cycle has reached a new peak with £23 billion. At this point, it is unclear if 2020 was the trough, or if 2021 will see further decline in origination and increasing LTVs.”

Aparna Sehgal, Partner at Dechert LLP, said:

“2019 late-cycle trends clearly could not indefinitely continue. Setting aside the human cost, which has clearly been too high, the disruption provided by 2020's events will continue to provide opportunity for investors into 2021 and beyond. Unlike 2008, the market fundamentals are strong, and a wide spectrum of lenders remain available to provide liquidity.”

Peter Cosmetatos, Chief Executive of the Commercial Real Estate Finance Council (CREFC) Europe, said:

“Covering the first six months of 2020 and just one COVID-impacted round of interest payment dates, this report merely hints at how commercial real estate finance might be impacted by the massive exogenous shock wreaking havoc across the economy.  

“It is not a surprise to see low origination volumes largely involving re-financings and loan extensions, a dearth of big ticket lending opportunities, and a clear trend towards the perceived resilience of residential and offices.

“For now, typical LTVs and pricing appear to have shifted only modestly, and sensible lending terms at origination continue to protect loan books from significant stress. There is surely worse to come.”

Neil Odom-Haslett, President of the Association of Property Lenders, said:

“The first six months of 2020 have been transformational in so many ways. 

“All of us will have been affected and touched by the pandemic in some shape or form. As a lender, it has been an incredibly challenging period and will continue to be, as we work with all stakeholders in addressing the issues that the pandemic has brought.  

“The findings of the CRE Lending Report are not a surprise as lenders hunker down and assess their respective loan books. They must also prepare for the next few months, if not years, as real estate readjusts to the new normal and particularly the accelerated change to the retail sector.”

Phil Hooper, Head of Real Estate at NatWest, said:

“This relevant and timely analysis illustrates the extent to which lenders have on the whole maintained a conservative approach throughout the last cycle. As we head into uncertain waters over the coming months this past prudence will stand us in good stead to face the challenges ahead.”

Ian Malden, Executive Director at Savills, said:

“It is notable that a proportion of lenders did not provide new finance in the first half of 2020 and, more recently, many have needed to assist their customers with interest payment holidays and loan extensions. 

“The Report notes, however, that this will inevitably lead to a deterioration in the quality of loan books and higher capital costs over time.  

“Each property sector in the UK has been heading along a nuanced path, with an acceleration of trends in many of the markets. The already evident challenges in the retail and leisure sectors have intensified, whereas the warehousing sector has been bolstered by the increasing switch to online. 

“The potential desire to occupy space, particularly offices, and the ability to pay for it will be fundamental to the performance of the property sectors going forward, which perhaps suggests that many lenders will increasingly focus on security of income.”

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