2019 REF review and the year ahead
As we enter a new year, and a new decade, Fieldfisher's Phil Abbott and Richard Gibbard provide a market update on real estate finance (REF) in 2019, and their predictions for the year ahead.
In the real estate finance market, Fieldfisher acts for bank and non-bank lenders, sponsors and the service providers such as the independent security agents as well as borrowers/sponsors/developers. Working for lenders gives us good exposure to the pipelines and the appetites of banks and non-bank lenders.
Out of our Manchester office, we act on bridge loans for boutique bridge lenders so we have a unique overview of the whole market, as we see a range of deals from these small bridge loans to the big-ticket Loan Market Association style bespoke structured property financings in the London market.
We have a particularly strong track record advising on operating asset deals, including hotels, care homes, student accommodation, ground rent portfolios and the private rental sector.
In addition to the typical secured real estate financing transactional work, we are increasingly involved advising on loan-on-loan financings, debt structuring, restructuring and on special situations, where we involve other experts from the firm, including our leading tax and insolvency practices.
Principally, a shift of lenders to continental Europe, where deal volumes increased and deal volumes in the UK declined. Real Estate Capital magazine, a long-standing and highly regarded trade paper for the REF industry reinforced this view looking at the nominations for its annual awards survey.
Retail took a pounding in 2019 and while lenders exposure to the retail market continues to decline, many lenders will have exposure of circa 25% to the retail market. While there were positive news stories at the beginning of the year with certain investors calling the bottom of the market, we suspect this is only for the right assets in the right locations for repurposing.
We have seen a number of retail deals refinanced by the existing lenders, and de-leveraged. There was probably little competition for those deals.
BBC Panorama's recent programme on retail stated that Local Authorities have spent 775m on buying back distressed retail in the past three years. We can probably expect this number to rise in 2020.
We saw less restructuring than we expected and much less enforcement. We think this reflects increasing consensual resolution of matters rather than through a formal legal process.
We saw more development financing than we expected, principally in alternative asset classes, which we have focussed for some years. Broadly speaking, the shift to these assets seems to be partially a response to retail woes, perhaps Brexit related, but also as the lenders are following the money, and investment activity has grown.
We are seeing lenders specialise, to really get to know an alternative asset class, which is sensible in a competitive market, but may raise questions in the future about market exposure. Specialising also means they maximise their win rate.
We are also seeing a shift to hybrid investment loans. Typically, loans would be categorised as either an investment loan, where it is gearing on a property that is already built; or a development loan financing a construction. We are seeing a move to what can be called a 'hybrid loan' - where there is a built asset that needs some modification or refurbishment - and is becoming a product in its own right.
What very much drives a lender's appetite to do business is its regulatory capital treatment. How is that loan treated on its own balance sheet? Banks allocate a certain amount of capital as a buffer against losses and different types of real estate are treated differently. That is why we are seeing alternative asset lenders emerging as increasingly dominant players in certain sectors and traditional lenders limiting their exposure.
While most segments of alternative real estate remain regarded as relatively new and untested in the long term, we are seeing student-housing maturing as an investment class and becoming recognised as mainstream. The private sector is still growing, and though possibly reaching capacity in certain towns, the segment is still very interesting for foreign investors - especially from the US, Middle East and Asia - and brand is becoming more important to the operators in this market.
Mid-January 2020 saw the Bank of England and the Financial Conduct Authority (FCA) make a joint statement encouraging the loan market's transition away from LIBOR before the end of 2021. This is nothing new. Since the LIBOR scandal erupted in 2012, regulators and industry bodies have been advising market participants on ways to wean themselves off using the interbank lending rate and to find ways to remedy existing contracts using LIBOR.
What was new in this particular statement was the unflinching demand that market participants cease writing new sterling LIBOR loans by September 2020. It appears regulators are losing patience with loan market participants seemingly dragging their feet over transitioning away from LIBOR.
Regulators have made clear that they will keep regulatory tools "under review" and may penalise sterling LIBOR issuances after September 2020. This may include, without limitation, action against Senior Managers and/or increases in regulatory capital/risk weighting for sterling LIBOR exposures.
The FCA and the Bank of England will be actively monitoring banks' efforts to transition away from LIBOR rates, particularly sterling LIBOR. The regulators expect banks to act promptly to accelerate their efforts to transition to non-LIBOR rates and there is increased focus on new sterling LIBOR issuances to put an end to the growing pile of LIBOR loans that need transitioning to a new rate mechanism.
For further detailed information on LIBOR discontinuance, head across to our IBORs micro-site.
Out of our Manchester office, we act on bridge loans for boutique bridge lenders so we have a unique overview of the whole market, as we see a range of deals from these small bridge loans to the big-ticket Loan Market Association style bespoke structured property financings in the London market.
We have a particularly strong track record advising on operating asset deals, including hotels, care homes, student accommodation, ground rent portfolios and the private rental sector.
In addition to the typical secured real estate financing transactional work, we are increasingly involved advising on loan-on-loan financings, debt structuring, restructuring and on special situations, where we involve other experts from the firm, including our leading tax and insolvency practices.
So what did we see last year?
Principally, a shift of lenders to continental Europe, where deal volumes increased and deal volumes in the UK declined. Real Estate Capital magazine, a long-standing and highly regarded trade paper for the REF industry reinforced this view looking at the nominations for its annual awards survey.
Retail took a pounding in 2019 and while lenders exposure to the retail market continues to decline, many lenders will have exposure of circa 25% to the retail market. While there were positive news stories at the beginning of the year with certain investors calling the bottom of the market, we suspect this is only for the right assets in the right locations for repurposing.
We have seen a number of retail deals refinanced by the existing lenders, and de-leveraged. There was probably little competition for those deals.
BBC Panorama's recent programme on retail stated that Local Authorities have spent 775m on buying back distressed retail in the past three years. We can probably expect this number to rise in 2020.
We saw less restructuring than we expected and much less enforcement. We think this reflects increasing consensual resolution of matters rather than through a formal legal process.
We saw more development financing than we expected, principally in alternative asset classes, which we have focussed for some years. Broadly speaking, the shift to these assets seems to be partially a response to retail woes, perhaps Brexit related, but also as the lenders are following the money, and investment activity has grown.
What are we looking out for in REF in 2020?
Specialising
We are seeing lenders specialise, to really get to know an alternative asset class, which is sensible in a competitive market, but may raise questions in the future about market exposure. Specialising also means they maximise their win rate. We are also seeing a shift to hybrid investment loans. Typically, loans would be categorised as either an investment loan, where it is gearing on a property that is already built; or a development loan financing a construction. We are seeing a move to what can be called a 'hybrid loan' - where there is a built asset that needs some modification or refurbishment - and is becoming a product in its own right.
What very much drives a lender's appetite to do business is its regulatory capital treatment. How is that loan treated on its own balance sheet? Banks allocate a certain amount of capital as a buffer against losses and different types of real estate are treated differently. That is why we are seeing alternative asset lenders emerging as increasingly dominant players in certain sectors and traditional lenders limiting their exposure.
Alternative assets maturing
While most segments of alternative real estate remain regarded as relatively new and untested in the long term, we are seeing student-housing maturing as an investment class and becoming recognised as mainstream. The private sector is still growing, and though possibly reaching capacity in certain towns, the segment is still very interesting for foreign investors - especially from the US, Middle East and Asia - and brand is becoming more important to the operators in this market.
LIBOR discontinuance
Mid-January 2020 saw the Bank of England and the Financial Conduct Authority (FCA) make a joint statement encouraging the loan market's transition away from LIBOR before the end of 2021. This is nothing new. Since the LIBOR scandal erupted in 2012, regulators and industry bodies have been advising market participants on ways to wean themselves off using the interbank lending rate and to find ways to remedy existing contracts using LIBOR.What was new in this particular statement was the unflinching demand that market participants cease writing new sterling LIBOR loans by September 2020. It appears regulators are losing patience with loan market participants seemingly dragging their feet over transitioning away from LIBOR.
Regulators have made clear that they will keep regulatory tools "under review" and may penalise sterling LIBOR issuances after September 2020. This may include, without limitation, action against Senior Managers and/or increases in regulatory capital/risk weighting for sterling LIBOR exposures.
The FCA and the Bank of England will be actively monitoring banks' efforts to transition away from LIBOR rates, particularly sterling LIBOR. The regulators expect banks to act promptly to accelerate their efforts to transition to non-LIBOR rates and there is increased focus on new sterling LIBOR issuances to put an end to the growing pile of LIBOR loans that need transitioning to a new rate mechanism.
For further detailed information on LIBOR discontinuance, head across to our IBORs micro-site.