In its 30th annual Financing Property presentation hosted today, 19 June 2018, in Edinburgh, Savills says that the UK property lending market is largely stable. However, pressure on interest cover ratios (ICRs) and debt yields from a correction in values in certain markets, notably parts of the retail sector, could lead to some lenders offering lower leverage to borrowers when they refinance.
Savills cites the research from the CASS Lending Survey, which it sponsors, and notes that 73% of all outstanding debt is due for repayment in the next five years, with loan maturities set to peak in 2020 due to the large volume of loans drawn in 2015. This could cause some borrowers to seek alternative sources of finance, especially if values soften in the interim. With yields already low it will be challenging to replicate existing levels of leverage if sustainable ICRs are to be maintained. This will inevitably lead to lower loan to values (LTVs) which could prompt some stress at the point of refinancing.
According to Savills, while many banks either can’t or won’t increase LTVs due to regulatory restrictions and prudence, ‘alternative lenders’ could be attracted to such borrowers as they look to offer increased leverage at higher margins, although much will depend on the track record of the borrower. The next three to four years could therefore offer tremendous opportunities for alternative lenders and will further hasten the move of property debt from traditional banks to the alternative sector where Savills has identified approximately 100 lenders. In 2008 it says that the alternative sector accounted for circa 5.0% of lending - by 2017 this had increased to 25%, and this is deemed a conservative estimate.
In their theme ‘Should lenders and investors be worried about the rising cost of money?’, Savills notes that the underlying cost of money has increased over the past year in expectation of a rise in the Bank of England Base Rate: the five-year SWAP rate has climbed from 0.8% in May 2017 to approximately 1.3% – a rise of over 60% in a 12 month period – and three month LIBOR is also significantly up; this could exert pressure on values.
According to CASS, new origination levels were broadly stable in 2017 at £44.5 billion. 51% of total origination was refinancing and 49% was new acquisitions, indicating that lenders are replacing their maturing loans with new lending but not expanding significantly. In 2017, non-bank lenders increased origination by 21% in value terms compared to only 3% by UK banks. However, origination activity dropped 34% amongst foreign banks (excluding German and North American institutions), largely due to increased competition and a scarcity of large core transactions.
Craig Timney, head of the Edinburgh office and the Scottish valuation team at Savills, says: “Compared to a decade ago, on the whole the lending industry appears to be in a good place. Regulation, prudence and a healthy market have generated low LTVs and high ICRs and a diversified lending market has reduced the prospects of ‘contagion’. There is no room for complacency, but given the level of equity in the market, it’s less likely that a borrower will need to hand over the keys to the lender if values were to fall.”
“The rising cost of money won’t necessarily cause notable value shifts or worry the lending industry so long as the overall cost of finance remains relatively low, as is currently anticipated. However, in the face of pressure on ICRs and debt yields, it could lead some lenders to offer lower leverage, which could benefit alternative lenders who are prepared to go higher up the risk curve to generate better returns. This is particularly relevant to refinancing, as a gentle decline in values will create pockets of stress, as is already visible in certain areas of the retail sector.”
The commercial market
Savills says that in the commercial property markets the impact of rising interest rates are likely to be muted. At a macro level, the positive effect of 45 million savers receiving better interest on their savings will balance out the effects of modest rises in mortgage rates. In the property investment market the link between base rate rises and rises in property yields has weakened over the last 20 years due to lower LTVs and the increase of non-domestic investment into the UK.
Stuart Moncur, head of national retail at Savills, says: “While the news around retail remains downbeat, we do expect to see some upward rental growth over the next five years in strong locations such as Edinburgh and Glasgow that are a good fit to their catchment areas. Furthermore, excluding town centres forecasts from GlobalData suggest that retail spend in all UK locations will remain stable over the next four years compared with today, indicating there’s life in bricks and mortar retail yet. We therefore still see opportunities for retail investors. The trick, however, is to throw away assumptions about what constitutes a ‘prime’ asset, and instead look closely at the each individual asset performs and, crucially, how well it fits its catchment area.”
The residential market
In the residential market, with 61% of mortgage holders currently on fixed rates, Savills says that the majority of householders are relatively insulated against a steady rise in base rates, with it forecasting a 14.2% increase in UK house prices over the next five years.
Faisal Choudhry, director of Scottish residential research at Savills, comments: “The application of stress tests since 2014 mean the vast majority of existing mortgage holders should be able to absorb a moderate rise in rates. However, stress tests for new buyers are likely to act as a drag on house price growth as rates rise.”
“The Built to Rent market offers the opportunity to fill the gap left by buy-to-let investors who are feeling the pinch from taxation and regulation. BTR is gathering real momentum with a 36% annual increase in the number of units complete or under construction. More widely, the Government’s plans to increase housing delivery across a broader range of tenures is going to provide opportunities in the development finance sector. More demand for debt finance is likely to come from small and medium size housebuilders, housing associations and pioneers of new housing models.”