Living sectors, resi development and prime logistics lead the way for lenders
At Savills 35th Financing Property presentation launched in London on, Wednesday 24 May 2023, the international real estate advisor revealed that living sectors, residential development and prime logistics are the most favoured UK sectors by London’s lending community. According to Savills survey, these sectors also reflect the markets that respondents believe are most likely to see positive price movement over the next six months.
Nick Harris, Savills head of UK and cross border valuation, says: “Whilst the results of our survey show that there are some very obvious markets that stand out as firm choices for lending and investing, it is also interesting to note the divergence of views for lending into the same markets. Typically, we would expect market views to be broadly aligned, but the disparity underlines some of the fundamental challenges around the future outlook for pricing.”
Savills notes that this divergence in opinions has impacted on both pricing and transactional volumes. For the market to progress, this dislocation of expectation needs to narrow.
Addressing the question ‘Are we nearly there yet’ in terms of price discovery and volatility, Savills observes that, whilst this is clearly a difficult call, for the majority of prime assets pricing appears to be reaching a landing point, albeit subject to low transaction volumes. By contrast, price discovery for non-prime assets remains a work in progress, albeit the speed at which we have seen prices correct compared to previous downturns has been much quicker, which the firm notes as a positive for future market activity.
In terms of what might cause any further pricing volatility, changes to the occupational markets, which have so far been relatively strong, along with any further significant adjustments in working practices in the office sector are highlighted as areas to watch.
Moreover, the structural challenge of greening property assets continues to dominate conversations in the lending community and although many investors are making good progress, there is still a substantial amount of work to do in order to ensure properties meet the required EPC standards. Nick Harris continues: “There is a risk for those lenders who are exposed to assets that do not meet EPC standards, this could lead to the emergence of stranded assets and potentially stranded loans.
“The next few years will also see a significant amount of loans due for repayment and, whilst not unusual, this activity is being undertaken against the backdrop of rising debt costs, falling capital values and the potential risk of additional capital expenditure associated with ESG. As a result, capital structures are becoming stretched and where these cannot be cured, we may see an increase in sales, consensual or otherwise as lenders seek to recover their debt.
“Despite this, many lenders are looking to increase their market share. There are undoubtedly opportunities for lenders and this is generating some competition for the absolute best in class assets with strong sponsors.”
Addressing the commercial property market, Mat Oakley, head of commercial research at Savills, notes that the expectation for interest rates to come down will support price rises in some areas with prime logistics and offices predicted to recover first. He comments: “The rationale for investing in logistics remains the same with online retail and on-shoring to support demand moving forwards, resulting in the vacancy rate likely to reduce to 4% in 2024 and prime rental growth to average at 6% pa.
“There are definitely challenges for office demand but these have been largely overstated particularly when you take into consideration employment growth and density reduction. In London we are seeing 52% of requirements looking for more space with only 22% looking for less. We have also seen an uptick in prime office rents over the last three years in both London and the UK’s regional markets, which demonstrates the underlying strength of the sector.”
For retail headline rents continue to rise with food stores and retail warehouses, along with those assets in commuter locations, likely to outperform. Given that risk was already being priced into retail yields, it is expected that selective price rises may come sooner rather than later.
From a residential perspective, Savills highlights that price adjustments, triggered by the 2022 mini-budget, were not as fast or deep as seen in the commercial sector. Whilst more evidence is needed in the transactional market, the most recent data is showing a return to growth and prime London values have seen very minor adjustments.
Emily Williams, director in Savills residential research team, says: “The outlook for house prices is certainly more positive than the start of the year with growth starting to filter through, however risk remains if interest rates don’t come down in 2024.”
Savills also highlights the increase in the demand for refinancing in the residential sector with 2.5 million fixed rate mortgages expiring by the end of 2024. Emily Williams continues: “People will be facing a very different market when they come to refinance compared to when they originally took our their fixed-rate mortgage, although the increased stress testing that has been implemented by banks has ensured more cautious lending. As a result, we are not expecting to see significant levels of forced sales or homeowners not able to meet new mortgage repayments, which is what would drive significant price corrections.”