Listless UK commercial real estate market forces loan pricing cuts

New lending for commercial real estate (CRE) fell by nearly 10 per cent over the last 12 months – continuing a downward trend, according to Bayes Business School’s latest bi-annual report.

CRE loan volumes were down by 9.8 per cent year-on-year in the 12 months to 30 June 2024, reaching £16.7bn.

The mid-year 2024 CRE Lending Research is led by Dr Nicole Lux, Senior Research Fellow at Bayes Business School.

Dr Lux said: “This updated research reveals another difficult start to the year for lenders. They are competing fiercely for financing opportunities due to low transaction volumes in the UK commercial real estate market. This continues the trend that started with Brexit in January 2020 and the significant impact of events such as the covid pandemic.

Banks' historic dominance of sector fading

“While international and UK banks have lost market share over recent years, the undoubted winners are debt funds – which have seen their loan book market share nearly double, rising from 12 per cent to 23 per cent. When insurance companies are included, alternative lenders now hold 43 per cent of outstanding CRE loans.”

At year-end 2023 the research identified 34 per cent of loans, valued at £57bn, maturing in 2024. With only £16.7bn of new lending to replace these loans during the first six months, outstanding loan books have already experienced a decline of 5 per cent.

Other key findings include:

• Development finance hit a new peak, with £28.8bn of outstanding development finance and another £25.5bn ‘dry powder’ in undrawn financing facilities. UK clearing and regional banks are largely driving development lending.
• International banking activity in direct CRE lending has been declining since Brexit, falling from 33 per cent in 2018 to only 21 per cent by June 2024. In the same period, their share of new lending has declined from 30 per cent to 25 per cent.
• Lenders were competing on loan pricing terms including loan-to-value, loan margins, ‘all-in costs’ and covenants. Financing margins of prime assets such as office buildings has tightened by 15bps over six months; and by 43bps for secondary office space.
• Day one lending loan to value ratio (LTV) has increased slightly, averaging 55 per cent, and for residential investment 58 per cent.

Big squeeze on development financing margins

Interest in financing prime office and industrial properties remains strong, with more than seven out of ten lenders expressing a willingness to finance these assets. The two key assets that lenders provide development finance for are residential (provided by 49 per cent) and student housing (46 per cent). As a result, development financing margins have compressed significantly – by 44bps, to 414bps, for pre-let commercial development assets, and by 68bps for residential development.

The cost of speculative financing has declined slightly, by 4bps, to 477bps. For prime commercial and residential development assets, average loan-to-cost available is 62 per cent, but one quarter of lenders offer LTCs of 70 per cent.

Despite this improvement for borrowers with regards to loan financing terms, the situation looks less favourable for those seeking refinancing with current loan breaches and defaults. Loan credit quality is still under pressure, and the average default rate is close to 5 per cent across lenders’ loans books, with 9.8% of loan facilities experiencing problems such as covenant breaches.

This is particularly the case for smaller institutions with balance sheets or assets under management of less than £1bn worth of loans. These institutions, regardless of whether they are banks or debt funds, lack the economies of scale needed to lend to higher quality assets.