The second quarter of 2018 has seen a number of themes emerge in the real estate market that have influenced our clients’ actions.
The biggest themes, as we see them, were:
- The continued growth of new lenders as providers of capital across multiple asset classes
- The Bank of England rate rise in August
- CMBS making a partial return
Despite the slowdown in residential house prices, we’ve seen bank support for new developments remain buoyant. Fortunately for our clients in this sector, there appears to be increasing supply and consequently a pricing benefit for borrowers. With mezzanine lenders and debt funds active here, leverage levels can reach beyond 75% of costs. In two recently completed debt mandates – one bridging the sale period for developed units and another for a land deal, this healthy competition between lenders enabled us to secure all -in borrowing costs lower than expectation. We continue to see these competitive conditions, suggesting that lender confidence remains strong – good news for borrowers.
As we highlighted in our last digest, alternative asset classes within real estate continue to perform well. Here again, the traditional lenders are seeing competition with the ‘challenger’ banks providing debt support to our clients in those sectors. Amongst the deals we advised on this quarter was the £50m debt finance by Metro Bank for Impact Healthcare REIT, an owner of care homes across the UK. As with many ‘alternative’ sectors, the end-user demand for the assets is strong and less susceptible to an economic downturn – encouraging in terms of debt support across multiple sub sectors.
Interest rate rises
From a UK interest rate perspective, the main theme for this quarter was the lack of a rate rise until August, despite forward guidance issued earlier in the year that a rise was likely. As highlighted in the previous digest, volatility levels in interest rate markets have been increasing as the prospect of a series of rate rises has become more likely.
On the continent the ECB is growing in confidence and has turned its attention to reducing its balance sheet. Whilst we have seen signs of a taper-tantrum, suggesting the markets think that a monetary reversal would be premature, it is unlikely that the ECB will increase interest rates until mid-2019 at the earliest. As a result negative interest rates continue to be of concern and we are increasingly seeing borrowers hedging with Fixed Rate loans. Whilst these can be a more economic method of managing ones interest rate risk, borrowers should ensure that the termination provisions are consistent with their business plan.
In both the UK and Eurozone we are seeing a growing realisation that rates could be significantly higher when they come to refinance. As a result, pre-hedging solutions are being explored more frequently. Of these solutions, interest rate swaptions have often had the most merit.
The return of CMBS
CMBS (commercial mortgage-backed securities) as a financing option seem viable again with four deals done in 2018, for a total of Eur1.7bn. Although the current regulatory regime does not encourage insurance companies to buy the bonds without significant capital allocation against them, it does allow other investors, for example asset managers, to gain access to real estate debt risk. This has resulted in tighter spreads for some bond classes, than bank debt pricing for similar risk. It should be noted however that the latest CMBS issuances have been for single borrowers, only private equity firms, and are far simpler than the pre-financial crisis structures.