Commercial Insights - Real estate debt: the view from our Debt Advisory team
Will Matthews, Head of Commercial Research, speaks to Lisa Attenborough, Partner and Head of Knight Frank’s Debt Advisory team.
4 minutes to read
Will Matthews (WM): Lisa, you are in direct contact with lenders every day. What is your view on how their appetite to lend has been impacted since onset of the pandemic?
Lisa Attenborough (LA): Initially lenders paused on most if not all new lending opportunities whilst they took time to assess the risk on their loan books. Following this review period, lenders began to open up to consider new lending opportunities albeit rebasing pricing and leverage to reflect the higher risk environment we are operating in.
Different lender types have been impacted in different ways. The following two examples show these differences on a spectrum:
- Clearing banks across the UK and Europe – initially focussed (and still to a degree) on existing client base. Clearing banks also have to consider their wider loan book outside of commercial real estate. For example, they may have exposure to the retail sector at a corporate level, which means they will need to carefully manage their balance sheet in the coming months.
- Debt funds financed by private capital and not constrained by PRA regulatory capital requirements don’t have the same restrictions and considerations and in fact, are busier than ever.
WM: Are there specific property types that they are more willing to lend against, and has changed in recent months? Do you see it changing?
LA: Commercial real estate types that facilitate logistical operations and residential investment opportunities are underpinned by solid underlying demand, so continue to attract lender interest.
There are some property types that aren’t faring too well in the short-term, however. Student accommodation, for example, has seen lenders pull back from the sector initially, but this may well change as university applications are converted into PBSA (purpose built student accommodation) occupancy.
The traditional office space sector is subject to similar conjecture, with some saying lenders are unsure about investing in it, but we haven’t seen that yet. Lender demand is still there for offices both in London and regionally.
WM: How has pricing been impacted, and how much of this is additional risk premium applied by lenders to real estate, and how much a function of market interest rates?
LA: Different lenders are following different pricing strategies.
Insurance lenders are pricing on the basis of relative value, with corporate bond spreads initially spiking upon lockdown. As a result, insurers increased their real estate debt pricing. Corporate bond spreads have now returned to more ‘normal’ levels, so debt pricing has come down (albeit not to pre COVID levels).
Several investment banks have introduced pricing floors. Loan syndication (the process by which investment banks distribute and manage their exposure) slowed significantly during Q2 of this year. This led to congestion in the market and consequently, we are seeing investment banks managing their balance sheet cautiously.
For debt funds, target returns remain the same, but leverage has reduced therefore achieving the same level of return for lower risk transactions.
"Commercial real estate types that facilitate logistical operations and residential investment opportunities are underpinned by solid underlying demand, and continue to attract lender interest."
WM: What about future appetite for lending? How do you expect the pool of lenders to evolve over the next year?
LA: A lot depends on what happens with a second-wave and the shape of the economic recovery, and how both of those impact the amount of bad debts that banks will have to deal with in the coming year.
We are already hearing of clearing banks provisioning for losses which will impact future lending appetite. Barclays has set aside a higher than expected £1.6 billion to cover a possible rise in loan losses in the second quarter and Lloyds has announced recently an impairment charge of £2.4 billion for the three months to June 30 – a significant increase from the £1.4 billion in the first three months of the year.
In Europe, Banco Santander reported the highest provisions by a bank in continental Europe so far. The bank is holding back €1.6 billion specifically for losses linked to the virus. This provisioning will undoubtedly impact the lenders appetite for commercial real estate lending in the coming months and even years.
WM: Do you envisage a more competitive environment as debt funds raise more capital?
LA: Not immediately. One lender told us recently that “we have money to invest but we’re in no hurry to invest it”. For the short-term there will be a flight to quality both in terms of deals and sponsors who are being backed.
That said we have seen a number of new debt funds being set up, which eventually will drive competition, but I don’t expect to see that to result in more competitive terms until the economy begins to show signs of recovery.
Will Matthews
Head of UK Commercial Research
Lisa Attenborough
Partner, Debt Advisory