What does the Bayes biannual CRE lending review tell us?

Debt funds, covenants and the refinancing wave: Bayes biannual CRE lending review is out

Bayes Business School has published its latest biannual review of the UK CRE lending market. The top line is positive - new CRE lending grew sharply last year to its highest point in a decade, driven largely by non-bank lenders. However, delve deeper and the picture is mixed.

The majority of activity was refinancing rather than new investment, and lenders were cutting margins aggressively to compete for a limited pool of deals. Prime office margins dropped by nearly half a percentage point depending on lender type, a significant move in a short period. The structural shift away from banks continues apace. Debt funds have more than doubled their market share over recent years and, together with insurance companies, alternative lenders now hold close to half of all outstanding CRE debt. A key driver of their competitiveness on price has been the growth of back leverage, where debt funds borrow against their own loan portfolios to enhance returns, allowing them to reduce the margins they charge borrowers while remaining commercially viable. The result is that debt fund pricing is now broadly comparable to bank lending on sought-after deals, making them a genuine alternative rather than a last resort. That said, their documentation and credit appetite can look quite different from traditional bank lending including a tendency to lend at higher loan-to-value ratios, so borrowers need to be alive to that.

Development finance is emerging as another significant growth area. It now accounts for nearly a fifth of all outstanding CRE debt, with lenders focusing on logistics, residential and student housing, particularly on larger deals involving assets that meet climate and carbon reduction targets. As the pipeline of refinancing deals eventually normalises, development finance looks set to be a key battleground for lender market share.

Perhaps the most striking finding for lenders is the covenant gap as the report estimates that somewhere between 15 and 20% of existing CRE loans contain no financial covenants, meaning lenders have no contractual basis to intervene until a borrower actually misses a payment. With interest cover ratio levels under sustained pressure and £33 billion of loans maturing this year alone, that is a significant structural weakness in the market. In a benign environment it may not matter. In a less forgiving one, it will.

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