Diversifying into Debt

The global real estate investment market remains highly liquid; we saw record investment volumes of €312 billion into Europe in 2018 and the highest levels of investment into Central London since 2014 with capital coming from all corners of the globe.

We estimate that there is approximately £34 billion of global equity looking to deploy into London but a supply constrained market coupled with yields bottoming out, mean investors are on the hunt for returns.

Consequently, we are seeing a number of investors traditionally associated with the equity side of things looking to enter the debt space. UK and international investment banks as well as range of debt funds and large propcos are increasingly diversifying into debt attracted by the risk adjusted returns available. This has created a deep and diverse lending pool in the UK, competing for a wide range of opportunities to lend across a broad spectrum of real estate. Indeed, the depth of terms offered on the mandates we have seen over the past 12 months indicate that pressure to deploy is arguably now greater on the lender than the borrower.

This has also lead to more enquiries regarding the creation of loan on loan platforms, exemplified by the funding line we structured for LendInvest in the latter half of last year. These platforms, made up of both debt and equity, are opportunity driven, attracted by the chance to fill funding gaps left by the traditional clearing banks and the possibility of deploying more challenging loans with high rates of return.

So, while the lending pool is growing, the headlines around 100+ viable lenders can be misleading as different capital costs, funding costs, structural flexibility and risk appetite narrow the field significantly. Finding the right lender for the right financing is paramount and needs to meet the criteria for both parties involved.

Sustainability of cashflow, whether from investment assets, asset repositioning plans or ground up development schemes, is critical for lenders and it is not as simple as a straight leverage (LTV) play. Consequently, factors such as economic fundamentals, occupier demand and structural industry changes come into play and these are key aspect of the underwriting process for lenders.

As a result, after a very solid 2018, the outlook for 2019 is tinged with nervousness regarding the political outlook. While we expect that the vast majority of lenders will at the very least seek to match allocations made in 2018, lenders are keeping a wary eye on meaningful widespread declines in values. A fall in average capital values in the region of say -10% or more could put undue pressure on banks subject to slotting treatment; as the quality of the loans declined, Risk Weighted Assets would rise causing returns to fall. In these scenarios, refinancing opportunities could begin to emerge.

Retail is perhaps where these considerations are the most acute. Rather than take a blanket approach to “all retail is bad”, prudent lenders are more forensic in their assessment, particularly with regards to the proactivity of the sponsor in managing their relationship with their tenant and consequently how sustainable the rental income is. Where significant letting risk is encountered in the first couple of years of a loan, lenders have become scarcer and debt markedly more expensive.

While overall our forecast for 2019 remains positive, the next few months will undoubtedly make for an interesting year ahead!

By Paul Coates, Head of Debt Advisory and Structured Finance, EMEA, CBRE.