FINANCE: ‘Mind the gap’ was the key theme of debt conferences a couple of years ago. We all sat there scratching our heads, looking at the sheer volume of debt in need of imminent refinancing and the ever-growing sum of loans in default.
New capital coming in didn’t look like it was going to touch the edges.
It is surprising how fast the world can change. Last Thursday, I attended Hatfield Philips/LNR’s Commercial Real Estate Debt Forum held at the Langham hotel, W1. Rupert Gill, who is the head of the debt advisory and transaction management business, chaired a very insightful panel featuring ‘What are the trends and opportunities for 2015 in commercial real estate lending?’. There were many high-profile industry professionals serving as panellists and a lot to ponder.
It is clear debt margins have been squeezed over the last year, which has been driven by a significant increase in lending appetite from existing and new entrants. This supply has pushed up loan-to-value ratios and encouraged some lenders up the risk curve. So the question on many people’s minds is ‘are we back to 2006?’.
Before you start putting your cash under the mattress, the discussions of the day made me think about some key factors in such an analysis.
There is still a strong preference for London and the South East as well as strong regional cities. This means if you have a well-located, well-let property you may get knocked over in the rush of bankers offering competitive terms. However, with three years left on the lease of your slightly shabby (or even spanking new) office in Doncaster, don’t expect to be killed in the charge. Even on prime assets we are still seeing substantially more real equity remaining in the deal. Interestingly, on the syndication side there is also more debt being held by the originating banks – again a key difference compared with 2006. While the syndication market is still active, particularly where there are good relationships with the borrowers and support and understanding of their business strategy, it is facing strong competition from balance sheet lenders.
Meeting supply, the demand side of the equation for debt, is building. This is supported by the ongoing gap between net initial yields on property (plus expectations of rental growth) and debt costs. Arguably debt costs are reducing faster than yield contraction, with downward pressure on margins and continually reducing expectations for short- and medium-term interest rates. In fact, all-in debt costs are half the level of 12 months ago. This, of course, is supported by the fact that the five-year swap curve, currently sitting around 1.26%, is lower than it has been trending over the last 18 months, and significantly lower than the long-term average.
However, supply isn’t coming in to meet demand in all areas. There is still very limited liquidity in speculative development. This represents a profitable opportunity for those lenders that understand and price the risk well, and is a big difference compared with 2006. Of more concern for the health of the economy is a lack of liquidity for funding SMEs. The new entrants into the debt arena typically do not have the infrastructure to service this part of the market, preferring to focus on larger loans and stronger economic regions. Given that small businesses are the engine room of the UK economy this is quite rightly a major worry for the government. Policies designed to address this have had some, but limited, impact to date. Funding for lending, originally rather widely dispatched, in part missed its target audience but did give a boost to the property industry at a moment in time that was helpful.
So my conclusion is yes, we have moved a long way in the last couple of years; however, on the whole lenders are still discerning – we do not have a glut of speculative development and currently it is nowhere near 2006. Having said that, I am amazed by the shortness of memory, or maybe it is the lack of alignment between those investing and the ultimate source of those funds.
The train is chugging full steam up the hill and the scene is starting to be set for another roller coaster of a cycle – hold on to your hats.
Rebecca Worthington is chief executive at Lodestone Capital
