Real estate investment firms are prioritizing the review of their debt finance strategy at the moment, reports Jane Roberts of PropertyEU.
In a real estate finance special report to be published in the forthcoming November issue, she says advisors and debt advisors are reporting that debt reviews are more urgent than anything else, including investment strategy.
Paul Lloyd, founder and CEO of Mount Street, says the loan servicing and advisory business has never been busier. ‘For us, 2022 has been an unprecedented year, business-wise and by volume of work.’
Lloyd says the company has seen a jump in requests for both extra servicing surveillance on existing loans and pre-closing asset diligence on new loans.
‘For example, can we provide more oversight on the portfolios? Can we get further under the hood of the transaction? Can we provide amendments and waiver oversights such as suggestions and opinions where a surrender of a lease comes in, or the effect on the portfolio if there is the sale of an asset and the substitution of another asset?’
Philip Slavin, finance director at UK developer Quintain, says: ‘Everyone is extremely busy, particularly with short-term refinancings and people are talking about a lot of extensions.’
Market volatility has been particularly severe in the UK where the five-year Sonia swap reached 5.2% at the end of September. The price fell back on 17 October after the new UK Chancellor’s reversal of his predecessor’s 28 September ‘mini-budget’, to 4.7%. After the 3 November BoE rate announcement, the 5-year swap traded at 4.13%, the 2-year at 4.40% and the 10-year GBP swap at 3.78%, decreases, but all still much higher than a year ago.
Quintain successfully finalised a £277 mln (€314 mln) financing, its largest development loan ever, with US investment bank JP Morgan in September. The loan will finance construction of two residential buildings at Wembley Park in north London, with 769 homes including 665 Built-to-Rent.
The company had gone through a process with lenders for the deal in April-May and interest was high, Slavin says, ‘from UK high street banks through to various specialist funds and insurance firms.’
At debt and hedging firm Chatham Financial’s semiannual market update for real estate last month, attendees confirmed that reviewing debt financing strategy was their top priority.
And, in early November, Chatham Financial said the market was currently pricing in a further 0.60% of hikes at the final BoE MPC meeting of 2022.
These debt-induced headaches are having multiple effects on the operation of the property market, for both acquisitions and refinancing.
Slavin says different lenders are changing in different ways in response to the higher risk, but the biggest trend his team has noticed is ‘a stronger focus on debt yield’ - the metric determined by dividing an asset’s net operating income by the loan amount and the one that tends to come to the fore when lenders prioritise the time it would take them to recoup their investment in the event of default.
Slavin adds: ‘People are still interested in loan to value and interest cover covenants but debt yield is becoming the first thing lenders ask about.’
Dr Nicole Lux, author of the bi-annual Bayes UK Commercial Real Estate Lending Report, believes significant value falls are inevitable because in many cases, property income will fail to meet higher debt costs on refinancing or acquisitions.
‘Our analysis shows that property net income yields need to increase to over 6% across different property types, or property values need to adjust downwards by circa 35% to reach a new market balance,’ she said on publication of the last report in October.
Those borrowers able to access the public debt capital markets before they slammed shut in February are counting their luck. Not only will they have cheap and possibly longer-term finance in place but, as it is usually unsecured capital, DCM finance leaves investors with unencumbered assets.
This in turn makes any subsequent financing in the private debt market much less difficult, as Andrew Coombs, CEO of German and UK business parks investor Sirius, points out.
‘We were lucky enough to have got away €700 mln of unsecured corporate debt in the nick of time, with the second €350 mln tranche last year at 1.25%,’ he says. This represents around 75% of the listed company’s €964 mln of borrowings. ‘And it gives us €1.6 bn of unencumbered assets, meaning the company represents a much lower risk today despite the (more difficult) market’.
Of the remaining €264 mln of secured debt, Sirius recently refinanced €170 mln one year early with existing lender Berlin Hyp. The new seven-year loan will kick in next November 2023 when the cost will roughly triple, going up to 4.26% (of which 2.61% is the base rate and 2.05% the margin) but still only taking the group’s blended cost of debt from 1.4% to 1.9%.
What Sirius gets from the early refinancing is certainty. ‘We have 90% of our lending locked down at less than 2% blended for more than four years’ he continues.’ Our average lease length in our portfolio is three years so that gives us four years to go through the whole customer base and increase pricing before our interest costs rise above 2%.’
He says one of the things the group has learned and that’s really been emphasised since February’s DCM shut down is: ‘You must have a broad range of debt options. You cannot be complacent enough to think you can depend on one bank, one type of lending. You’ve got to have the flexibility all the way around the cycle’.
For the full report, see November’s issue of PropertyEU out soon.