Savills: disruption in UK property provides opportunities for lenders

Savills says that parts of the property sector are moving from a traditional based market to one where there is greater emphasis upon operational models, be it serviced offices or Build-to-Rent, with the shopping centre sector already starting to adapt. This is partly in response to the need to put the customer first and deliver exceptional service and experience. 
 
The customary way of lending to real estate is also changing and alternative asset classes are growing in popularity. Nevertheless, Savills says that there is caution amongst parts of the lending market to follow sponsors into the emerging sectors. Many lenders cite the lack of financial transparency from the operational entities as being a factor in this. However, as the operational asset market evolves and becomes more established, and the sponsors achieve a proven track record, it is likely that the emerging sectors, such as serviced offices, will become more acceptable to the lending fraternity, just as retail warehousing, and more recently student accommodation, once did.
 
According to Savills, lenders and valuers will increasingly focus on cashflow analysis and the operational performance of the occupier. In the office sector, there will always be an element of the occupier market that requires long leases and the reduced prevalence of such leases could create a new form of super prime lending asset. 
 
Craig Timney, head of the Edinburgh office and Scottish valuation team at Savills, said: “The property sector has been among the last to catch up in terms of the occupier experience, but landlords are now responding to tenant demand and are focusing on service and building relationships, which will increasingly have an impact on how assets are valued, as turnover rents become more common and leases shorten. Overall, the different forms of disruption seem to be having a greater impact on property than the traditional economic cycle, which is now 10 years in duration.”
 
The need to adapt lending methods to reflect the changing market has not dented lender appetite. There is strong demand for “bed” based funding (i.e. hotels, student, retirement living and care homes), which is reflective of the higher proportion of investment turnover in these sectors. Alternative lenders (non-bank lenders and insurance companies) have responded and continue to increase their market share, with borrowers attracted by their speed and certainty of delivery.
 
There are likely to be further opportunities for alternative lenders over the next five years, Savills says, as approximately 78 per cent of outstanding property debt will be due for repayment, up from 73 per cent reported last year, so the market will increasingly be dominated by the need to refinance loans. With the potential for capital value falls and pressure on rents in some sectors, Savills says that it may be challenging to maintain sustainable interest cover ratios (ICRs). This will inevitably lead to lower loan to values (LTVs) which could create some stress at the point of refinancing.
 
Mr Timney adds: “On the whole, the UK property lending sector appears to be generally well disciplined and relatively liquid, with finance available for most property sectors. But disruption is driving change: within the office sector lease lengths are shortening, and turnover rents are becoming more common in retail. The lending industry and the valuation profession need to adapt to these operational based changes. Lenders will also increasingly need to understand the equity story and the options available if challenges arise. There will be a greater focus on the quality of the income stream and debt yield as we increasingly move from long leases to operational income.”
 
According to Savills, disruption is driving the widest ever spread between total returns on UK retail, office and industrial property. Upheaval is most visible in the retail sector, with rental growth in decline and retail assets making up only approximately 15 per cent of the 2018 lending market, down from 20 per cent in 2017.
 
Occupier uncertainty in the retail sector and the rise of the CVA, together with the consequential shortage of debt finance, have resulted in low levels of investment turnover. Savills says that it has become increasingly challenging to predict the path of the net operating income, a direct reason why shopping centres have become less attractive to the property investment and finance market. The oversupply of retail space has led to many centres being ‘repurposed’ as owners seek to maintain value and create experience through alternative uses. The ideal is to create places where people want to socialise, shop, live and work. Investors are now placing less emphasis on shopping centre yields; it’s more about the true cashflow and geared returns. Schemes that have been repurposed and and/or are transparent in trading performance will be the most sought after in the market.
 
Isla Monteith, director in the retail team at Savills in Edinburgh, said: “The retail sector is clearly undergoing a period of disruption in the face of numerous retailer CVA’s and whilst this is inevitably having an impact on the retail property sector, we do recognise that physical stores remain important to UK retailers. There is definitely still a place for retail in our town centres provided it is right-sized and surrounded by complementary uses.” 
 
Faisal Choudhry, director of Scottish residential research at Savills, said: “Disruption in the residential markets is driven by demographic shifts, such as our ageing population and rising demand from single-person households. But those are slow burn disrupters compared to major political and economic change – Brexit uncertainty being the biggest factor currently impacting sentiment – and the shifting sands of policy towards, for example, Built to Rent, Help to Buy, Planning Regulation. These will in turn shape opportunities for investment and investor appetite in the sector.”