Despite the fact that many investors seem concerned about the potential for a Labour government after Thursday’s election there is a growing appetite for debt amongst UK commercial real estate investors. According to a report out today, more than 50% of UK commercial property loans were made on a loan to value ratio of 65% or more. This compares to a figure of 35% in the previous six-month period suggesting that demand for UK commercial real estate is still very strong.
While this demand is unlikely to reduce in the short to medium term there is some concern that the loan to value ratios, last seen just prior to the 2008 mortgage crisis, could cause problems in the future. So, why are so many UK commercial real estate investors happy to borrow on such high risk terms and why are financial operations happy to take on these arrangements?
Low outlay high return
The whole point about a high loan to value ratio is that for a relatively small down payment the investor is able to borrow a significant amount of excess capital based on the value of the property. While a 35% “buffer” between the full value of the properties and the higher end of the loan to value ratios seems fairly safe and sensible, is this really the case?
The problem is that while the relatively high ratio may look “safe” the repayment of the debt will be based around the rental income. If the value of these properties was to fall then this would impact the rental income which would impact the borrower’s ability to repay on time. As we saw after the 2008 mortgage crisis a relatively “safe” situation can very quickly turn on its head once the market turns downwards.
Why are lenders agreeing to such ratios?
There has been a renewed emphasis on regulating the domestic property market with politicians concerned about consumer debt in the future. It looks as though this has forced many lenders to look elsewhere with the UK commercial real estate market seemingly offering greater profit margins. It is worth noting that some of the U.K.’s largest listed property companies work on loan to value ratios in the region of 25% to 35% which illustrates the current market trend.
It is also worth noting that commercial real estate prices are being pushed higher on the back of greater demand. Even though the UK economy has stumbled of late it has been, and is expected to continue to be, one of the strongest in the Western world. The growing economy will be reflected in domestic and commercial property markets with many experts suggesting there may still be further upside in the short to medium term.
Is the market headed for a crash?
There is no reason to suggest at this moment in time that the UK commercial real estate market is headed for a downturn. We may see a period of consolidation, we may see some profit-taking but the general trend still seems to be upwards. While the risk reward ratio on a loan to value ratio of 65% is dramatically higher than those dealing at around 25% to 35% it seems many are still prepared to take the risk.