Lenders may be opting for volume over return, says Savills

Debt providers are converging on favored types of real estate, the consultant said at its latest Financing Property event.

Competition to write loans within favored UK real estate sectors has intensified, leading property consultant Savills to suggest some lenders may be prioritizing financing volume over returns in an overall slower market.

Speaking at the firm’s 36th annual Financing Property presentation in London, Nick Harris, Savills’ head of UK and cross-border valuation, said banks are looking for deals after deploying relatively little last year.

“Combine this with the fact debt funds are enjoying elevated interest rates, and it means all market participants are competing on a very low dealflow,” he explained. “For lending deals that tick all the boxes, borrowers are witnessing some very competitive terms. This begs the question of whether some lenders are now seeking volume over return.”

Harris said Savills sees a “totally polarized market” with intense competition for the best opportunities. For most, that means living sectors, residential development and prime logistics.

“It’s clearly difficult for these sectors alone to satisfy investor and lender demand,” he said. “We’ve seen increased focus on operational assets such as hotels, data center and flex offices. However, as market players take any opportunities, we may be beginning to see appetite reignited for former favorites such as retail.”

Popular operating assets also include student accommodation and self-storage, he explained. “For hotels, there’s a clear focus on opportunities in London and Edinburgh. New development opportunities, particularly the conversion of redundant offices to hotels, has also been a growth area for those lenders with appetite for development funding.”

Lenders clearly also want to do more residential development financing, he said. “Year-on-year, we’re seeing lenders increase leverage sizing, reduce ICR [interest coverage ratio] requirements and cut margins. This is a very sought after sector with the challenger banks and alternative lenders, in particular.”

Harris noted an overall improved sentiment from lenders. “They feel they have probably seen the worst. There’s a more positive sentiment, albeit there remains some debate around the timing of the recovery and there remains some concerns over negative debt positions.”

Refinancing activity is likely to increase throughout this year, with around £35 billion (€41 billion) of debt expected to mature, Harris explained. “Of course, with higher borrowing costs and declining values in many subsectors, when investors come to refinance or restructure a loan, there is a risk there will be a gap between the level of debt required and the amount of debt lenders are willing to offer. So, how this funding gap unravels over the next few years remains a concern.”

Limited distress

So far, Savills has not witnessed a large amount of distress in the UK. “There are always pockets of distress, often illustrated by consensual and non-consensual sales coming through, which is a feature of most recovery cycles. However, to date, despite the obvious stress in the market, we have not seen wholesale distress,” said Harris.

However, he added regulated lenders may seek to remove impaired loans from their balance sheets to ensure they do not restrict future lending. “It’s conceivable therefore that as liquidity continues to improve, some lenders seek sales to exit and recover their loans. Should we witness a surge in non-consensual sales, in a condensed timeframe, there is a risk of sudden price declines, potentially reshaping the parameters of price discovery.”

Also speaking at the event, Mat Oakley, head of Savills’ UK and European commercial property research team, said he has fielded queries from international investors about distressed UK opportunities.

“The simple fact is distress is quite a few years off,” Oakley said. “The peak of distressed selling in the global financial crisis across the UK and Europe was about three years after the worst moment. The market will start to recover, prices will start to recover, then people start to feel more confident about bringing these distressed type assets to the market. It could be quite a few years before you see that moment where you can buy real distress.”