Money market problems have cast a shadow over the UK’s $1.6 trillion commercial property sector

Written by Sinead Cruz, Elizabeth Hawcroft, and Lucy Rayetano

LONDON (Reuters) – Owners of Britain’s largest shopping malls, skyscrapers and industrial hubs are facing rising borrowing costs and a recession that could cut prices by as much as a fifth, forcing lenders and investors to reassess their appetite for commercial property.

Developed economies globally are struggling to cope with the far-reaching consequences of the end of years of ultra-loose monetary policy, which kept asset prices high and the cost of debt low.

So far, the shock of this reversal has hardly affected Britain, where clashes between policymakers over how to revive growth and stem inflation have led to dramatic repricing across sterling money markets.

As homeowners grapple with a sudden rise in mortgage costs, a sudden rise in five-year swap rates in the UK has sent chills through Britain’s $1.6 trillion commercial property sector, where asset prices could fall by as much as 20 percent. % by the end of 2024, according to analysts at Goldman Sachs.

Data from MSCI, which tracks monthly changes on 1,794 properties valued at around 37 billion pounds ($41.55 billion), showed values ​​tumbling 2.6% in September, the biggest monthly drop since July 2016, a month after Britain voted to leave the European Union. European.

Commercial real estate investors such as real estate investment trusts (REITs) rely on the ability to earn more rent and profits from sales than they spend on expenses, including debt and capital costs.

Earnings data showed that Bellwethers such as Land Securities, British Land and Hammerson pushed major refinancing beyond the expected mid-2023 peak in the Bank of England’s benchmark interest rate.

But good financial management is just one challenge, as expenses for labour, fuel and goods also increase the risk of cash-strapped tenants handing over their keys.

Although banks are less exposed to risky mortgages than they were before the 2007-2008 global financial crisis, banks are already on the alert for breaches in loan terms tied to the market value of the asset or rental income related to the secured debt, the sources said.

If these terms, or covenants, are breached, investors may need to refinance earlier than planned, at higher rates. Goldman Sachs analysts expect the total financing costs of the UK listed real estate companies they cover to rise by 75% over the next five years.

James Lidement, managing director of Kroll’s real estate advisory group, said commercial property prices had already been hit by higher borrowing rates, which had been a primary cost to residents and investors alike.

“Given the likely number affected and the level at which interest rates are expected to rise, lenders may have to agree to covenant waivers in an effort to stabilize the loan books,” he told Reuters.

UK REITs use less leverage now than they did before the financial crisis. But as property values ​​have plummeted, average loan-to-value ratios have risen to 28% from 23% at the start of the year, according to Zachary Geoge, head of real estate research at UBS.

5 year sterling interest rate swap

Occupational risks Concerns about financing costs come after years of worrying about rents for some REITs, as the pandemic has emptied offices, stores, bars and restaurants, reducing corporate demand for space.

Office occupancy rates in the UK have been around 30% in recent weeks compared to an estimated pre-pandemic average of 80%, according to Remit Consulting.

Vacancy rates in leisure and retail properties also remained above pre-pandemic levels, according to local data company figures, at 10.6% and 15.4%, respectively. The footfall of UK retail destinations was down about 15% on average in 2022 compared to 2019, according to Springboard data.

The demand for office space in central London, particularly in older buildings, is also weakening.

CBRE said only 2.6 million square feet (241,548 square meters) of space was allowed in the third quarter, down 30% from the second quarter and 14% below the 10-year quarterly average.

Some occupants are cutting costs to reduce costs and energy consumption, which is likely to further pressure real estate companies’ rental income.

HSBC told employees this month that it will reduce its office space globally by about 40% from 2019 levels.

The lender could give up his home in the iconic skyscraper in London’s Canary Wharf as part of a broader review, while at the same time working to integrate staff into fewer floors in the 45-storey tower, reducing occupied space by 25%. Marks and Spencer is accelerating its plans to close 67 larger “full-line” stores over five years in a blow to property owners and neighboring businesses.

Standard business rates, a tax imposed on commercial real estate, are likely to jump by 3 billion pounds next April, the largest annual jump since 1991, after inflation hit 10.1% in September, the month the following year’s rates were set.

“…More business failures and store closures will result unless the UBR is frozen again,” said Jerry Schorder, Gerald Eve’s head of business price policy.

The stock market is also signaling growing investor caution about UK commercial property, with the 15 UK REITs down 44% so far in 2022 compared to a 9.8% drop in the broader FTSE 350.

Some international investors have also reported British developers’ concerns about their ability to finance construction.

“The developer says: We would like to sell it now, or we are more open to selling it now, and to a large extent we are willing to give away a percentage (…) of the developer’s profit in order to keep the We are moving forward.

UK REIT Index vs. 30 Year Gold Return

(dollar = 0.8906 pounds)

(Editing by Tomasz Janowski)

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