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By Hamish Armstrong (PR and Communications Manager (Interim)), Published

The latest Bayes UK Commercial Real Estate Mid–year 2022 report shows a new lending volume of £23.7 billion, indicating strong appetite for new business up until June 2022 before deal flow started to dry up. In a dramatically different interest rate environment, lenders are prepared to pass on new opportunities for the second half of the year if it is not a good opportunity.

Findings by Dr Nicole Lux, lead author and Senior Research Fellow at Bayes Business School (formerly Cass), show that the alternative lender segment has now experienced twelve years of continuous growth, growing on average 15 per cent per year.

The report uses data collected from 79 major UK lenders, and indicates a new increase in commercial development finance, with lenders confirming their financing support for transitioning assets, carbon zero assets and assets with clear improved Environmental, Social and Governance (ESG) credentials.

Key highlights from the report, which covers data up to June 2022, also show:

  • Development lending made up 22 per cent of new origination in 2022, showing a new increase in commercial development finance, which for the first time, post-pandemic, includes speculative development finance.
  • Debt funds have taken on larger scale asset transitioning projects, and supplied 72 per cent of commercial development finance.
  • Margins for prime office loans compressed by five basis points (bps) across six months, showing the high market competition during the first half of 2022. However, for other property types margins for 60 per cent loan-to-value (LTV) increased by between five and ten basis points.
  • Small to mid-size lenders concentrated 89 per cent of their lending in residential development finance, with ‘Other Lenders (debt funds)’ supplying 25 per cent of new residential development loans and UK Banks supplying 58 per cent.
  • Generally, smaller lenders have been less likely to refinance existing borrowers and hence, have the lowest client retention rate, generating most of their business from new acquisition lending.
  • Underperforming and defaulted loans remained stable for now, with an average default rate of three per cent.  

With the announcement of interest rate increases in January 2022 followed by the start of the energy crisis related to the outbreak of the war in Ukraine, UK public bond issuance dropped to a low of £4 billion during the first half of 2022, according to the Bayes Bond Monitor.

The high incremental cost of debt is forcing developers and property companies to change their business models from a debt-funded acquisition model to a capital-light owner/investor model. Some developers are considering funding new construction with 100 per cent equity.

British banks have been dominating their own market, providing 35 per cent of new financing, followed by debt funds which held a share of 24 per cent. Alternative lenders together (debt funds and insurance companies) have been responsible for 38 per cent of new loan origination. On the other hand, International Banks have seen their market share gradually decline from 34 per cent to 28 per cent over the last 10 years. Overall, the largest 12 originators were responsible for 58 per cent of new loans, of which five were UK Banks.

A large pricing gap also remains between the largest and smallest balance sheet lenders, resulting in a price differential of 0.8 per cent for prime office. For example, prime office loan margins for the largest lenders stand at an average of 1.98 per cent while borrowers can expect to pay an average loan margin of 2.77 per cent when borrowing from smaller lenders.

When asked generally about lending appetite for 2022, prime office and prime industrial are the two property sectors that most lenders are willing to finance (93 per cent and 85 per cent respectively), followed by prime residential investments (81 per cent).

Dr Lux said:

“Interest payments and property income were approaching a 1:1 ratio by June 2022, and with the five-year Sonia swap reaching 5.2 per cent by the end of September 2022, property income will not be sufficient to refinance some properties at these rates, leaving a potential funding gap.

“Our analysis shows that property net income yields need to increase to over 6 per cent across different property types, or property values need to adjust downwards by between 25 and 35 per cent to reach a new market balance.”