Review: Inaugural Capita finance survey turns spotlight on UK's CRE lending market

By Paul Norman - Thursday, June 29, 2017 9:30

The Inaugural Capita Real Estate Finance Market Trend Analysis report, which aims to provide a regular analysis documenting the UK commercial Real Estate finance market, has revealed a string of insights into the key trends and issues for lenders. Capita has identified a “relative value consideration” through a correlation between Average Maximum LTV versus Average Margin for each lender type. Other sentiment focused outputs include appetite to increase new lending originations as well as team size in the forthcoming 12 months.

CoStar News teamed up with Capita Real Estate Finance earlier this year to launch and cover the survey and its findings. The survey aims to provide a regular analysis of the market, providing an overview of UK lending, with a series of questions on lending trends, the type of lenders operating in the market, and future expectations.

Key findings of the inaugural report include:

• Hugely diverse lender pool with 12 distinct lender categories

• Stability in pricing and leverage forecast to continue with increasing loan origination volumes

• A divergence in pricing between lender categories means there is more of a relative value consideration for borrowers to make

• Long term borrowing is well priced at the moment but fewer lenders are able to provide it and income covenant requirements on such debt are high

• Almost everything is financeable – black spots of availability exist where two or more negative deal aspects combine (e.g. undesirable sector plus weak location)

• Allowing a longer time to complete a financing can result in superior pricing

• Very little macro nervousness - lenders have broad ambitions to increase loan volumes as well as manpower

Capita’s survey is based on a detailed lender survey focused on appetite. Capita says that by providing a "forward looking focus on lender appetite and policy, the report provides an opportunity to look into the art of the possible".

The initial report finds a market characterised by a strong desire to lend from an increasingly diverse range of lenders.

Accentuate the positive

Overall lenders are seeing a more positive macro environment in which to originate loans this year than last and believe this will continue, Capita finds.

Approximately half of lenders (52%) see their company increasing head count in the next year but even more, over 70%, saw their new loan originations increasing in the same period showing that there are a number of lenders who believe they “can do more with what they have in a competitive environment”.

No banks see a decrease in head count or loan originations coming in the next year which Capita said “begs the question as to whether the UK clearing banks are now through the worst of the restructuring cycle or whether their origination teams are still in denial about their prospects”.

On funding reference rates, respondents generally do not think the UK base rate will fall below 0.25% and Gilts are unlikely to dip again but there are varied opinions on whether funding costs will remain stable or whether rates will rise in the next 12 months. 

On LTVs the survey finds that “stability is a consensus” and an expected continuing rebound in transactional volumes a year on from the referendum means it is likely lenders will be able to maintain underwriting standards and risk appetite while increasing loan originations.

While it is possible to obtain non-recourse finance at fixed all-in interest rates of below 2.50% for five year terms and below 3% for 10 year terms on the best investment stock Capita questions how long this will continue.

Leverage and pricing

On average across the UK market, the report finds the maximum achievable senior LTV for investment loans is 72%.

For development loans, the average maximum leverage on offer is 76% LTC equating to 65% of a project’s GDV. However these broad averages hide a wide variation in maximum leverage between lender categories, Capita reports.

Maximum leverage for both investment and development loans is obtainable from hedge funds with maximum LTVs on investment loans exceeding 90% and, for development loans, LTCs just shy of 90% or 80% LTGDV.

Perhaps surprisingly insurance companies averaged at 70% maximum leverage matching or exceeding all banking lender categories. Capita points out that the seemingly high leverage point is skewed by a focus on income rather than value.

This is evidenced by the fact that insurers required the highest coverage of debt service payments through income at an average of 1.92x, it said. Other lenders require 1.2x – 1.7x.

German banks and insurance companies offer the lowest cost of senior debt reflecting average margins of 200bps with Asian, European and local UK banks all following closely behind.

Capita reports: “For bridging and mezzanine debt, if you can fund these types of debt through a bank, you will secure the lowest funding costs. The same is true of whole loans with Debt Funds following closely behind but if you are seeking preferred equity or participating debt, then you will need to approach Alternative Lenders and Funds.”

Relative value

The survey usefully averages the data in each lender category to provide a ‘relative value’ based on maximum leverage offered against margin pricing. The lender categories above the trend line are relatively ‘good value’, offering higher maximum leverage for lower average margins when compared to those below the trend line (see chart).

Capita says the average maximum LTV versus average margin chart reveals how much relative competition there is between lenders to lend at average margins of between 200bps and 350bps. Capita Real Estate Finance has recognised a trend of diverging pricing in the market as a result of regulatory creep affecting lender categories differently and the “gradual splintering of market share giving rise to greater amounts of issued debt being funded through alternative funding sources.”

Income Covenants

The average ICR and DSCR requirements of lenders reveal that insurers and banks are the most income focused in terms of underwriting with funds and alternative lenders being more open to a sponsor’s returns being capital weighted. This is also borne out in the leverage maximums (i.e. higher LTV loans generally indicating that a lender sees an increase in the value of the asset(s) coming).

Sector and geography

The survey finds that all sectors and locations are fundable but for each sector or location, market depth varies widely.

Office is the most popular investment asset followed closely by retail and, in development, residential is by far the most preferred with student housing and office tied in second place.

Hotels are the most challenging to finance both in investment and development. Capita says this is in part because many bank lenders will separate this asset class into a different origination team who would be less likely to respond to an all-real estate survey. That said other lender categories also favour most other asset classes over hotel.

Development finance is one area which does present notably more challenges in securing finance. For 100% pre-let commercial and for residential development for sale projects, 68% and 71% of all lenders would consider funding, respectively.

For residential projects that number falls, only slightly, to 66% when the units are to be held and rented rather than sold. For commercial projects, however, 71% falls to 58% when projects are only part pre-let and falls dramatically to 30% on speculative commercial development.

Land without planning is the hardest asset type to finance.

Geographical preference

Unsurprisingly London and the South East top the charts for regional lending appetite. Scotland is the least preferred region of the UK. Capita says this is a result of the “intricacies of the legal system and the threat of a second independence referendum rather than the depth of the real estate market”.

Loan profile: Loan maturity and ticket sizes

In reference to loan maturity, longer term money is more difficult to come by with only 30% of lenders lending in excess of seven years and only 11% over ten years. Of these, insurance companies were the most prevalent lender.

Capita adds: “For investment loans, the market for very large tickets (>£500m) is thin on the number of active lenders but highly competitive on pricing whereas the market for very small tickets (<£10m) is awash with lenders but pricing is notably higher. This is predominantly due to the higher relative cost base for lenders in the small ticket space.”

Deal completion

For banks in general, the survey finds it takes one to three months to complete a financing. If a borrower is a ‘new-to-bank’ client, then it is safe to leave closer to three months than one to complete.

Insurers and Pension Funds are “somewhat longer still with some indicating a longer process than three months as an average”. Hedge Funds tend to be the quickest with a two to four week average with alternative lenders and debt funds not far behind.

Capita said there is some negative correlation between pricing and deal completion time.

“Those lenders taking in excess of three months to complete a deal generally price at around half the cost of those completing quickly, so perhaps good things come to those who wait.”

James Wright, Head of Real Estate Finance at Capita Real Estate Finance, said: "We found a hugely diverse lender pool in the UK, with 12 distinct lender categories. That diversity means almost anything is financeable, there are some black spots but lenders have significant ambitions to expand originations which bodes well for financing higher leverage requirements and/or challenging assets.

"One of our most interesting outputs is the relative value assessment of lenders showing those who are relatively good value and relatively poor value at any leverage point. This combined with the other detail in the report should give borrowers a better idea of where to go to secure optimal financing solutions for any particular asset, portfolio or project."

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