Looking forward at lending: an interview with Lisa Attenborough

Q: What impact are volatile swap rates and the changing economic landscape having on lending to commercial real estate and how will this change over the coming year?

Over the past six months, driven by economic uncertainty following the war in Ukraine and near record high levels of inflation, the lending market has experienced seismic change. The most notable impact of this uncertainty has undoubtedly been the sharp increase in interest rates and corresponding volatility in the swap markets.

After benefitting from over a decade of historically low interest rates, many borrowers are now seeing swap rates at an all-time high. This brings the corresponding ripple effect of increased execution risk for deals already in documentation and also, due to the increased cost of financing, means that a number of high-profile transactions have been put on hold as bids fall short of expectations.

Looking to the future, both borrowers and lenders must shift their mindset on interest cover ratios. Instead of aiming to achieve the previously healthy ratios, upwards of 2.50x for example, tighter ratios of 1.25x and above should be considered the norm.

In the coming year we expect rates to continue to rise, requiring lenders to work closely with borrowers in order to find suitable debt structures, particularly as it relates to refinancing.

Q: How do you envisage lender appetite evolving over the coming year and which types of lenders will be most active?

A: We expect lender appetite to remain resilient in the coming year, albeit on a more selective basis. It’s important to note that unlike in previous economic downturns, lenders remain incredibly well capitalised and willing to make funds available for the right opportunities.

Historically, in volatile times, non-bank lenders have out-performed traditional lenders. They are able to offer greater flexibility on terms and often have a more streamlined – although also more costly – credit approval process.

As banks tighten their lending requirements over the next year, borrowers will have the choice of procuring debt at a higher cost or deploying greater amounts of equity into a given transaction, and this should present opportunities to alternative lenders.

Q: Which specific property types will lenders be more willing to lend against over the coming 18 months?

A: A further feature of unsettled times is that lenders are more risk averse about the assets they’re willing to lend against and we’re certainly seeing the start of a flight to quality in the market. Lenders have increased their due diligence and are being more selective on which assets they take forward.

Asset classes that have performed well in recent years, particularly those which have demonstrated resilient income streams over the course of the pandemic, will remain a focus to all lenders.

Logistics, build-to-rent and the counter-cyclical PBSA market are among the sectors well positioned to deliver strong income in the medium-term.

We also expect best-in-class assets with generous cashflows in less core sectors, retail and hotels for example, to continue their recovery in the lending market.

Q: How is lender appetite varying across regions?

Lenders are increasingly focused on locations with solid economic fundamentals and a good depth of investor activity. These include the major European cities sought after for their office and residential sectors alongside strategic hubs for industrial and logistics sectors.

In the UK, we’ve seen a number of senior lenders pull back from established regional cities. Instead, they are focusing in the short-term on London and the South-East, viewing the capital as a safe haven in uncertain times.

Across Europe, appetite remains strongest in mature markets. Germany, the Netherlands, Spain and France all offer a resilient range of domestic lenders alongside international banks and alternative lenders.

Q: What impact is sustainability having on access to commercial real estate financing? How do you expect this to evolve over the coming year?

The sustainability of an asset has become a crucial component of every funding transaction. In recent years, the ability to demonstrate appropriate green credentials has enabled borrowers to benefit from preferential margins and receive more favourable terms.

While this arguably remains the case for a proportion of lenders, increasingly the most competitive lenders in the market demand that all new deals meet a minimum suitability requirement before offering terms.

Looking to the future, assets with insufficient sustainability credentials are going to be increasingly difficult and costly to finance unless a suitable business plan with clear performance indicators is agreed with a lender to upgrade the asset.

You can read more about the financing outlook for 2023 in an interview with Emma Winning, Partner, Knight Frank Capital Advisory.