Is the Boris bounce real or a myth? For all the hopes for stability from the Conservatives’ win in December’s General Election – not least in the real estate market – the reality of the ongoing Brexit negotiations still threatens to bring even the most upbeat dealmakers back down to earth with a thud.
Anecdotally, at least, buyers, developers and their financiers are gearing up for work. Nicole Lux, senior research fellow at Cass Business School and author of the Commercial Real Estate Lending Survey, welcomes a newfound sense of optimism in the market. “Lenders across the board are telling me that they are a lot more busy,” Lux tells EG in a podcast discussion.
But Lux, whose role overseeing the long-running survey sees her canvass views and volumes from all types of lenders active in the UK, expresses some cynicism over whether a rosier sentiment will necessarily materialise in a rise in deals.
“I do believe agents are putting a positive spin on the market to get it going at this point – we will see how many deals that really translates into,” she says. “There is a bit of the Boris bounce, you could say. But I’m still a bit sceptical as to where we will be by mid-year for example, when we’ll have more of an idea where negotiations with Brexit go. Definitely, though, lenders feel a lot more positive for 2020.”
Among those lenders is Aldermore Bank, which has been growing its commercial real estate offering and two years ago increased the size of maximum development loan to £25m.
For John Carter, commercial director in the bank’s commercial real estate team, an unseasonably busy January in the deal market – “I’m sure Boris would wish to take credit for that” – has been welcome after the challenges of last year.
“In 2019 there was certainly a cliff edge mentality taking us to [the original Brexit date of] March and a lack of activity really in January to March last year,” Carter says.
“Property’s still a long-term play. So [political uncertainty] doesn’t switch off decisions, but it does mean that people have held back. And I think that pent-up demand and pent-up planning is really starting to play through now that the uncertainty of the General Election has been removed. Certainty of a way forward, I think, has given people a bit more confidence to go take those decisions they were maybe trying to hold off from if they could.”
Work-out time
While new investment deals will be welcome, refinancing is likely to be a significant driver of loan market activity this year, Lux says, given that the UK market saw a peak in origination, according to her surveys, in 2015-2016. “These are the loans now, in 2020, that are [up] for refinance – so we would expect to see quite a bit of activity on that,” she says.
Pricing of property finance has proved reasonably stable but competitive nonetheless, Carter and Lux agree.
“That risk/reward discussion is becoming a lot more disciplined and evolved in terms of where the market sits today,” Carter says. “In terms of the amount of real estate debt that’s out there now, it’s a lot more structured, thought through, instead of the rush to the highest loan to value and the lowest price, which clearly was part of the pre-global financial crisis issues.”
One segment of the market that has repriced, Lux notes, is retail. “Where we will see some repricing and where there is leverage and a bit of concern is those areas of retail where borrowers will have no other option but to fill the equity gap by asking for mezzanine loans,” she adds.
“That’s already happening. And those mezzanine lenders will ask for very high IRRs, obviously. That’s where we see some over-leverage and some people losing money.”
At Aldermore, Carter says the bank’s exposure to retail is mostly through loans on mixed-use developments in which there is “a natural hedge that you’ve got some residential space above some retail”. For many others, he adds, repurposing may be the only viable option as the traditional retail markets shift and leave some properties impractical in their current guises.
For Nicole, whose October instalment of the lending survey offered multiple pessimistic accounts of the retail outlook from financiers, there is “no positive news” for the sector.
“It seems clear that we don’t need all the retail space that there currently is and some locations just won’t work any longer,” she says. “There is a serious concern from the lenders’ side, obviously, and they’re working through those scenarios.”
Fire sales of retail assets this year will likely give clarity on pricing, Lux adds.
“What we expect to see for 2020 is a lot more sales due to the fact that some of the retail funds have been under pressure,” she says.
“Lenders are also expecting that some of these will be forced sellers and that will lead to new valuations and a new level of pricing for these assets, which really was very vague in 2019. And that will then prompt some lenders to look into other strategies – whether they’re going to go down the receiver route and whether they’re going to go down the work-out route.”
All about alternatives
While retail will remain in the doldrums, alternatives are likely to remain in favour.
“The alternative asset classes are key at the moment,” Lux says. “Everybody is still very interested in lending into student housing – although they feel it’s slightly overpriced – and everybody is interested in doing more PRS deals, but they’re limited in finding any sort of sizeable transactions.”
Carter says Aldermore will remain an active lender for student accommodation projects, although he adds that as that sector expands, questions need to be asked over whether cities in which development has become particularly significant now have either too many such schemes or too much of the wrong kind of accommodation.
“I agree on PRS and build-to-rent. It is an area for focus,” he adds. “I think the changes in buy-to-let and tax is driving a difference in terms of people who are operating in that space. There is a definite demand from some investment companies to buy into that as an end product, so the actual development of that still has an exit route.”
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