There is a wall of debt capital available for property investors and developers. This is especially true in London, but it is also filtering out into the regions. Where is all this capital coming from?
Perhaps even more interestingly, what form is this capital taking, and what trends are we seeing today in terms of debt?
Firstly, there is a lot of bank debt available today. Although it may not be back to pre-2008 levels, in the past two years we have seen a number of banks enter or re-enter the UK property market, and existing lenders have increased their allocation of capital to real estate debt.
Today, banks from all over the world are lending on UK real estate assets – including banks from Europe, the Middle East, the Far East and the US. This is creating real competition for the UK banks, and has driven down margins being charged to borrowers significantly over the past 24 months.
Fortunately – for lenders, and the market as a whole, I would say – covenants and leverage don’t seem to have moved much at all. This is probably owing to regulation, including slotting; however, even non-bank and overseas lenders not subject to these factors also seem to be holding firm on covenants and leverage.
Non-bank lenders are the fastest-growing segment of capital providers, albeit from a low base. According to research from De Montfort University, non-bank lending as a share of the total market rose from 9.4% in 2012 to 19.2% in 2014. This represented gross lending of £11.8bn in 2014. Figures for 2015 are forecast to be higher still.
The non-banking lending market is dominated, first and foremost, by the insurance lenders. The other growing providers of debt include funds, specialist lending companies, sovereign wealth funds, family offices and peer-to-peer lenders. We at Urban Exposure, for instance, are an example of a non-bank lender. Today, some of the largest loans in the UK are being provided by non-bank lenders.
The advantages non-bank lenders have over banks include their ability to transact deals speedily and operate under fewer regulatory constraints. However, very few funds can compete with the cost of bank debt. So why is the non-bank lending sector growing so rapidly, and is this a potential risk to the real estate market?
The non-bank lending sector is growing rapidly because of the still-limited supply and increasing demand for debt for complex projects from less well-known borrowers. Many factors explain why demand for real estate debt is so strong; one, for example, is the UK’s image as a safe haven for overseas capital; the UK’s chronic housing shortage combined with an increasing population; rising disposable incomes for the population as employment grows while inflation remains subdued; low interest rates, making debt servicing much more affordable; and so on. And supply has increased as investors see attractive yields in real estate debt. These can be sophisticated investors with trillion- dollar funds, or individual retail investors. All are searching for, and finding, yield in real estate debt.
In terms of risk, on the whole, what I see from non-bank lenders is actually very smart, astute lenders that understand both real estate and lending. Even more importantly, these lenders are less likely to be a systemic risk to the economy than banks, because they are lending equity. That being said, it is almost inevitable that, as the cycle continues to unfold, more lenders will enter the market. My hope is that this does not lead to a reduction in underwriting standards, but only time will tell.
Worryingly, I can see some early warning signs that will need close monitoring. For example, more lenders increasing competition in the marketplace, more lenders apparently funded by equity, but which are in fact relatively geared; and more lenders with investors that perhaps cannot fully understand the risks of real estate debt.
While there is no clear problem as at today’s date, the supply of debt capital to the real estate market is fundamentally important for the UK economy and therefore we cannot afford to be complacent.
