The commercial property lending boom is over and the market is taking its first tentative steps on the road to recovery.
According to the latest study of bank lending to commercial property by De Montfort University, debt secured by the UK real estate sector went down for the first time on record by 0.6 per cent falling from £225.5bn (year-end 2008) to £224.1bn (2009 mid-year).
However, loans in breach of financial agreements doubled in the first half of 2009 to about £30bn, with £18.6bn reported in breach of covenants and £11.8bn in default – the equivalent of South Africa’s entire commercial property market.
But despite the well-publicised problems of key lenders, banks have retained their faith in property. The number of active banks is rising and debt is available, albeit in more limited quantity and at higher prices than previously. The importance of a handful of German banks and Santander cannot be over-estimated.
While many feared large fire-sales of assets as banks called their loans in, this has not happened – yet. Since property values fell by about 45 per cent since the peak of the boom in 2007, many were in breach of loan agreements which are set against the value of the property.
The steep and rapid drop in values meant that many property firms were, like homeowners, facing a negative equity time-bomb.
De Montfort University has been publishing this survey – paid for by the UK real estate sector with the support of many of the banks which are surveyed – for a number of years and it becomes more authoritative each year. The significance of the survey is not simply the sizes of the sums involved but the level of transparency it offers to the business community.
The number of loans in breach of covenant is surprisingly small at £18.6bn – or 8.6 per cent of the total stock of loans – but the survey is to June 2009 and states that banks are much more interested in borrowers’ ability to service interest liabilities than in loan to value breaches. Added to this, with RBS in the Asset Protection Scheme, the National Assets Management Agency (NAMA) up and running and Lloyds about to complete its rights issue, it would be reasonable to expect the defaults to increase significantly.
The occupier market is still expected to struggle through 2010 and if tenants go under it could mean propertyowners being unable to service debt.
Many have been focusing on the stock of debt and the way that the banks are dealing with their problems. But the future health of the sector depends on the availability of new debt and here the news is quietly positive.
The number of banks seeking to increase loan origination to property has doubled in six months from 23 per cent to 50 per cent and the number of banks who are prepared to lend has risen from 73 per cent to 87 per cent – which suggests that, while there are organisations wanting to exit the sector, banks in general continue to regard property as good collateral.
New lending this year was limited – at £7.4bn in the first half, compared to £49bn in the whole of 2008 – and is more concentrated than ever, with 12 organisations accounting for 83 per cent. UK lenders, perhaps surprisingly, had a 58 per cent market share.
Most of the rest was accounted for by a small number of German and other international banks, the largest of which is almost certain to be Santander although the report does not explicitly say so. As a consequence, half of the UK market depends for its funding on access to the pfandbrief market (a long-established German form of covered bond) and the ECB.
Lending against income-producing assets continues to dominate loan books at 74 per cent of the total: speculative development funding is practically non-existent with the flow of new lending even more focused on investment finance than the existing stock.
The proportion of lenders willing to provide mezzanine funding has fallen from about 70 per cent in 2006 to less than 15 per cent today.
Liz Peace, chief executive of the British Property Federation, said: “There is clearly a process underway of banks reducing their exposure to commercial property but it seems likely to be a slow and long, drawn-out one. New originations have fallen pretty dramatically but we are also seeing extensions and overall debt has remained static.
“Indeed, there are also clear signs that some banks are getting more interested in commercial property again, albeit on a somewhat qualified basis, no doubt on the basis that values have fallen significantly and good term can be achieved by lenders willing to lend.
“There are also clear signs of a fairly polarised market. The real availability of new debt seems to be heavily concentrated in lower-risk assets.
“While more loans are reported as being in default, it probably remains the case that lenders are willing to leave loans in place if the interest continues to be paid, even if they are in breach of financial covenants.”