While lending volume on UK property held up at £23.7 bn in the six-month period to 30 June 2022, its author Dr Nicole Lux said that by June 2022 rising debt costs meant that ‘interest payments and property income were approaching a 1:1 ratio.’

Debt costs have continued to rise in Q3, with the five-year Sonia swap reaching 5.2% by end of September. Although the price fell back on 17 October after the new UK Chancellor’s reversal of his predessor’s 28 September ‘mini-budget’, the five-year swap was still at 4.7%, much higher than a year ago.

At the same time, lenders’ margins have continued to rise to reflect higher risk, and credit is rationed.

‘Property income will not be sufficient to refinance some properties at these rates, leaving a potential funding gap’, Lux said.

‘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.”

Euan Gatfield, head of EMEA CMBS at Fitch Ratings, one of the sponsors of the report, said: ‘Properties with rental yields that did not normalise through the pandemic - and in the case of industrials, actually dipped to record lows - will face a meaningful value correction as debt finance becomes markedly dearer.’

Lux used the following example to justify the opinion that yields need to increase to 6% on income-producing good quality offices. She puts the yield on these assets at 4% at 30 June. Based on the 30 September 5-year Sonia rate of 5.2% added to the Bayes’ report’s average reported margin for the asset class of 240 bps (and assuming that didn’t rise in Q3), the all-in borrowing cost is now 7.6%. The -3.6% spread results in the interest coverage ratio falling short at only 0.7%

The Bayes survey is based on evidence from 79 lenders.

Positive news in the report for UK borrowers is that while debt is more expensive, the lending market is diverse and there is liquidity. In particular, the non-bank lender segment has now experienced 12 years of continuous growth and in H1 2022 was responsible for 38% of new loan origination.

Paul Coates, head of debt at CBRE Capital Advisors, said: ‘The Bayes report continues to demonstrate the diversity and depth of liquidity in the UK lending market which should give cause for confidence in the future.’

Since the period covered by the report, borrowers looking for large tickets have recently announced they've been able to turn to investment banks; examples are Morgan Stanley underwriting a circa £1 bn refinancing for Kings Cross Limited Partnership, announced in September and Bank of America’s £1.25 bn for AXA IM Alts’ 22 Bishopsgate.

‘There is a pricing point where US banks come into the market for such big loans and usually on deals where underwriting is more difficult’, Lux commented.

If as expected, private debt market volumes do decline dramatically in H2 2022 they will be lagging the public market, where there was only £4bn of sterling bond issuance in H1 2022.

‘Looking ahead to H2, my sense is that it will be very different from H1’, said Neil Odom-Haslett, president, Association of Property Lenders .