Market Summary

The banking market has largely seen a continued shift away from consumer focussed assets; in particular to sectors that have been less impacted by Covid-19, specifically residential investment and logistics/warehousing.

Across the board, an increase in Risk Weighted Assets and re-evaluation of risk ratings has driven increased banking conservatism, with a noticeable flight to high quality, core assets, at a maximum 50% LTV and mainly for existing clients. There are of-course exceptions but, anecdotally, there seems to be a general migration of lower-rated loans (both new originations and refinancings) from banks to the alternate lenders. Despite this, a funding gap is likely to persist.

A report by AEW has estimated the UK debt funding gap will reach £30bn over the three years to 2023, with half of the outstanding loans being in the retail sector. This is the result, not only of restricted appetite from traditional lenders, but also the falling asset values seen in retail (£9.5bn) and alternative assets (£13.5bn) such as care homes and hotels.

The alternate lending market will continue to grow to meet the surplus demand. The latest INREV report found that debt funds raised a record €32bn in 2020 for global real estate with returns for these funds averaging 7.7%, illustrating the profile of deals these funds will compete on. A second report from AEW has estimated non-bank lenders will account for 40% of commercial real estate new loan origination in Europe over the next 2 years. While this was a trend seen pre-Covid-19, it has certainly been accelerated as a result of the pandemic.

For existing loans, where covenants have been waived and/or maturities extended, it is likely that lenders will be less willing to extend forbearance, especially as moratoriums are lifted, giving landlords a greater deal of control over asset performance. The approach is likely to differ depending on the sector, with wholesale forced sales unlikely and lenders cooperating with sponsors where possible. However, there is an acceptance that a long-term solution will need to be found that reflects the viability of the assets in question. Where asset values have fallen this will mean either paying down the loan or re-pricing to reflect higher leverage.

It is worth noting that the trend of short term maturity extensions in 2020 will likely result in a ‘bottleneck’ of refinancings in 2021/2022.

The successful roll out of the vaccination programme has so far led to a positive shift in market sentiment and a general increase in market activity. While there is limited data for 2021 yet, JLL reported £19.4bn was invested in UK real estate in Q4 of 2020, a 6% increase from the previous year and making up over 45% of annual investment. With roll out of the vaccine appearing relatively successful in the UK compared to other countries, this may filter through to increased transactions, particularly from overseas investors. However, it may be that we do not see the real impact until later in the year.

The residential and industrial markets continue to perform well, and yields remain tight. We have also seen multiple sale and leaseback (S&L) transactions come to market as operating businesses look to raise equity. Savills recently reported that the second half 2021 is expected to see a record number of S&L transactions across Europe, fuelled mainly by logistics occupiers taking advantage of low yields. These transactions can be attractive to lenders looking for long-term stable income, however we have seen this is dependent on the tenant’s credit rating and lease length.

Spotlight: Hotel Market

The hotel sector has become an increasingly important sector in CRE lending, with debt origination to hotels growing by 141% since the GFC. The sector has also been one of the worst impacted sectors from COVID-19, with many hotels forced to shut for most of the last 12 months and even when they were allowed to open, saw a restriction in foreign travel and overnight stays.

Hotels, as with other sectors, were the beneficiaries of government and regulator pressure on lenders to apply leniency over the course of the pandemic and various lockdown periods. However, we are now seeing lenders re-evaluate and apply more pressure on borrowers. This has left many hotels, currently seeing little or no cashflow, in what has been coined as situational distress. Otherwise stable businesses with coherent business plans may face difficulty in refinancing any maturing loans.

We have seen debt funds and challenger banks step in to offer a lifeline to borrowers that are no longer able to secure finance with mainstream lenders. These funds are often able to offer more flexible terms and take a more speculative view on the situation. By way of example, Westfort have recently secured terms from debt funds and challenger banks for refinance and capex facilities to support the refurbishment and re-branding of a hotel, following the latest Travelodge CVA.

A report by Cass Business School found that average senior lending margins on a hotel of good credit quality, at an average LTV of 58%, rose from 270bps to 305bps in the first 6 months of last year, and was closer to 400bps by the end of the year.

Lenders are also looking for more protection when they do make loans, with targets on Interest Coverage Ratios (ICR) rising from 1.8x to 2.2x, with some lenders requiring 4x for managed hotels that do not benefit from strong brand association. In fact, 78% of lenders preferred financing hotels with a franchise or renowned brand, hence some independent hotels have been forced to join a renowned brand in order to refinance.

Headline Transactions / News

MGT’s £150m Battersea BTR Purchase

Pan-European investment and asset management firm MGT investment have purchased the remaining 92 flats in Battersea Power Station’s electric Boulevard. This highlights investor confidence London’s long-term fundamentals as a prime market.

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£1bn of live business park deals in the UK

With three significant deals currently progressing, the business park sector remains strong in the UK due to attractive yields. Deals include Singaporean listed Frasers Property’s £180m acquisition in the Midlands.

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Report on Hotel lending market

A report by The Business School (formerly Cass) and Berkeley Capital Group on lending in the UK hotel sector in 2020 showed margins increased from 2.7% to 3.05% for an average loan of 58% LTV in the first 6 months of the year. It is expected average for the end of the year would be 3-5% for a hotel with good credit quality. As lenders consider the increased risk, they have been lending at lower LTV ratios, and requiring much higher interest coverage ratios. It also highlights what we have seen with banks lenders retreating from the market and debt funds likely to be the main source of new originations in 2021.

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