COMMENT Earlier this year, we undertook our first private client sentiment survey, gathering data from 110 high-net-worth individuals who are investing in or developing UK real estate, with a total net worth of £12.2bn.
Sentiment was overwhelmingly positive, with all respondents seeing the UK as appealing for real estate investment and viewing the macro-economic disruption as an opportunity rather than a barrier. They saw opportunities in line with their entrepreneurial tendencies as we emerged on the other side of Covid-19.
Since then, the war in Ukraine has erupted; inflation has hit double digits for the first time since 1971, with interest rates rising in response; and we now face the very real threat of a recession. More pertinent for the real estate world, the cost of debt has become a hot topic.
It’s interesting to reflect on how the mood may have shifted in the four months since our research was published.
Room to manoeuvre
Our research showed that ESG had become a top agenda point, with 99% of private clients surveyed facing external pressures on sustainability.
However, anecdotally, sentiment seems to have shifted slightly as investors deal with more pressing matters. This is frustrating on a number of fronts, as the record temperatures we experienced this summer are a stark reminder that those issues aren’t going away.
Our research highlighted the punitive VAT tax regime for residential refurbishment projects compared with new development, with 69% of respondents believing this is an environmentally unsound policy, not to mention misaligned with the UK’s 2050 net zero commitment.
There are clear environmental benefits to refurbishing buildings with the inbuilt carbon capture. It’s perhaps appropriate that the tax bands are levelled out as a simple measure to incentivise green development – one for the new prime minister, perhaps?
Turning to the rise in interest rates as a measure to depress inflation – with base rates having already risen significantly and markets suggesting they could peak at 4% next year, loan covenants are coming under pressure for the first time since the global financial crisis. Interest coverage ratios – the percentage that annual rental income exceeds interest costs – form a key part of a lender’s criteria and are an early warning sign of the ability to service a loan.
It is therefore a vital time for lenders and borrowers to come together in a collaborative way. However, unlike in the GFC, lenders’ loan-to-value ratios are much lower, which provides room to manoeuvre. For new lending, the LTVs on offer will reduce as stress serviceability is considered. For example, the maths suggests it is very challenging to borrow more than 50% LTV on prime residential investments and maintain a positive ICR, due to its low-yielding nature.
Defensive characteristics
Our research showed that residential for sale and residential for rent were the two most attractive asset classes, with 49% and 47% of investors believing they will be particularly appealing over the next five years. However, investors will require more equity than previously.
It remains a high-conviction sector for Investec, especially the for-rent market, where there is a continued supply-demand imbalance, and we are seeing first hand our clients’ high-quality, well-located and well-priced schemes being let quickly.
With real wages falling at record rates and higher mortgage costs, its defensive characteristics are clear. Despite the current economic situation, which may test private clients in the months and years ahead, we remain optimistic and so do our borrowers.
At nearly 30 years old, we are ready to utilise our strong client relationships and entrepreneurial mindset to help borrowers take advantage of opportunities that may arise and manage through what we all hope is a short spike in interest rates.
William Scoular is head of private client lending at Investec
