UK CRE: Challenges Remain Ahead

There remains ￡170 billion of commercial real estate (CRE) loans outstanding as of year-end 2023, according to the recent Bayes Business School CRE lending report. This is going to present opportunities and challenges depending on where lenders and sponsors find themselves in terms of market position. Of the ￡170 billion, Bayes reports 60% is due to mature within the next three years, posing a significant refinancing challenge, particularly for UK and German banks, which face over 80% maturity rate.?

As the industry braces for a ‘refinancing wall’ amidst high interest rates, there remains lots of uncertainty. Particularly, the impact of a new UK government coming into power and needing to finance spending,?alongside the impact of imported inflation from the US, which is experiencing stickier inflation and may need to keep rates higher for longer.?

If they do, the UK will likely follow to some extent and the ability of assets to generate the necessary cash flow for loan repayment will be brought into focus.?

Sectoral Headwinds

The vulnerability of the CRE market is further exacerbated by the concentration of loans in the retail, office and hotel sectors, which account for nearly half of all outstanding loans. This is worrisome, as the past year has seen these sectors, especially secondary offices, hotels, developments, and retail spaces (excluding retail parks), struggled the most. As loan-to-value (LTV) and interest coverage ratio (ICR) thresholds are tested, the key question is how will lenders respond.??

Current Stability vs Distress: A Delicate Balance?

Despite the looming challenges, the default rate and reported breaches remain low at 4% and 5% respectively, totaling less than ￡5 billion. This is a stark contrast to the peak of the Global Financial Crisis, where defaults soared to a yearly peak of approximately ￡36 billion.

The current stability can be attributed to more conservative leverage levels and robust post-crisis banking regulations. With 86% of CRE loans reporting LTVs below 60%, the banking sector’s balance sheet remains resilient, but the question remains: for how long??

Banks' Response: Amend & Extend, but What’s Next??

Banks have so far shown a preference for ‘amend and extend’ strategies over taking possession of distressed assets. Yet, as the maturity wall nears and interest rates remain higher for longer, the sustainability of this approach is under scrutiny. Debt funds in particular, are seeing a shift in credit extension with a growing proportion of loans below 2x and therefore falling into the ‘troubled’ ICR category.?

Critical Role of Proactive Stakeholder Engagement

In anticipation of increased market distress, a proactive approach by lenders and sponsors involving a broad spectrum of restructuring strategies is essential. This will likely result in an uptick in consensual deals including debt/equity swaps, asset/portfolio sales, restructuring plans, and company voluntary arrangements (CVAs), as well as Plan B options, including administrations and fixed charge receiverships.

Early and active engagement with stakeholders is crucial to navigate financial stress and unlock a wider range of options for a consensual resolution.

Feel free to get in touch with me, Chad Monerville or any of our PwC UK real estate restructuring team if you have any questions or need any general advice.

*This analysis is based on data from the Bayes Business School Commercial Real Estate Lending Report for year-end 2023.