In the current environment, bank lending to property will likely stay weak. Moreover, falling values are expected to lead to an estimated £30bn re-financing gap in the coming years, which will put pressure on investors to find other forms of finance or face selling assets.
- In the current environment, bank lending to property will likely stay weak. Moreover, falling values are expected to lead to an estimated £30bn re-financing gap in the coming years, which will put pressure on investors to find other forms of finance or face selling assets.
- Even before the COVID-19 crisis, demand for new lending to commercial property in the UK had slowed, for a few reasons. For one, while interest rates were low, lenders’ margins were rising. Secondly, average loan-to-value requirements for new loans had been pushed as low as 50-55%, meaning that some investors were unable to make their numbers work. Finally, caution around Brexit hurt investment activity, which has been slowing since 2015 and resulted in lower demand for new loans.
- According to City University, new lending to real estate fell 34% y/y to £15.5bn in H1. Even then, most of that activity was in refinancing deals. Admittedly, this has not come through in a sharp decline in the Bank of England’s (BoE) net lending figures as we had expected. (See here.) We think this reflects lenders granting short-term payment holidays to landlords, thereby reducing repayments on existing loans. More positively, even the previous rise in real capital values has not resulted in a pick-up in property debt like in the run-up to the GFC, so the immediate risks to the banking sector are low. (See Chart 1.)
- Looking ahead, the demand for credit is likely to remain weak. There have been few signs that investment will pick up notably in H2. That’s unsurprising, given that capital values are still likely to fall in the remainder of the year, not to mention the possibility of more restrictions and uncertainty around Brexit. As a result, we expect a weak end to the year for investment activity will keep a lid on demand for new loans.
- More importantly, the availability of credit has already tightened this year and is likely to worsen further. Lenders have already increased loan margins by 20-50bps y/y in H1, suggesting a calculated pull-back from the market. More specifically, lenders’ willingness to originate new loans is dependent on the asset’s sector. For instance, they seem willing to lend on industrial and office assets, but wary of retail and leisure. According to the BoE Credit Conditions Survey, lenders expect to reduce the availability of credit in Q4, largely due to the weak economic outlook and expectations of lower commercial property prices.
- With concerns around falling values, lenders to retail landlords look most exposed. AEW recently estimated the debt funding gap – the mismatch between the outstanding debt and what is available for refinancing – will be by far the largest in the retail sector. (See Chart 2.) This will account for nearly half of the £30bn shortfall up to 2023. Although this would still be less than half the gap seen between 2008 and 2011, we think it will be difficult to bridge and there will be pressure on investors to sell assets.
- On balance, both demand and availability for new loans are likely to remain subdued for the coming months. And with a marked re-financing gap in the coming years, we think this raises concern that investors that are unable to bridge the gap may need to find alternative lending sources or sell.
Chart 1: Real Capital Values Index and Property Debt
Chart 2: COVID-19 UK Debt Funding Gap (£bn)
Sources: MSCI, Refinitiv, Bank of England, Capital Economics
Sources: Cass Business School, CBRE, AEW
Prohad Khan, Property Economist, firstname.lastname@example.org