During 2023, the UK’s commercial real estate sector faced a significant downturn as new loans reached a historic low. According to a report from Bayes Business School, total loan origination plummeted to £33 billion, marking the lowest level in ten years. This drastic decrease reflects the challenges posed by declining property values, rising debt costs, and the mounting pressure to manage troubled loans effectively.

Shifting Lender Focus

The lending market has shifted dramatically, with only 28% of loans allocated to finance new acquisitions— the lowest percentage since records began in 2007. This indicates a cautious approach from lenders, who are now more concentrated on sustaining existing loans rather than financing new projects. Chris Gow, head of finance and structured debt for Europe at CBRE, emphasised that lenders are currently prioritising the assessment and management of their problematic loans.

The Impact of Rising Interest Rates

The commercial real estate sector has been particularly vulnerable to the recent increase in interest rates, transitioning from a period of ultra-low costs to significantly higher rates. This change has not only made it more difficult to fund new deals but has also strained existing investments, as property values decrease and debt payments increase. This scenario contrasts sharply with the post-2008 financial crisis period when lenders could quickly resume financing new assets after addressing non-performing loans.

A Slow Market Recovery

Nicole Lux, a senior research fellow at Bayes and the author of the report, pointed out that the current downturn differs from previous ones. There has been a noticeable absence of distressed assets being pushed onto the market at reduced prices, which typically helps in resetting property values and hastening market recovery. This leniency from lenders may delay the market’s recovery further.

Declining Deal Activity

The first quarter saw European real estate transactions drop to a 13-year low, continuing a downward trend for the seventh consecutive quarter. Specifically, in the UK, deal-making fell by 11% year-on-year from already low levels observed early in the year. Despite the market’s challenges, Richard Fine, managing director at Brotherton Real Estate, noted that there was still considerable capital looking for investment opportunities in debt, which has helped prevent widespread distress in the market.

Notable Financial Moves

Recent developments include the South Korean investor Mirae opting to refinance the debt on an office building on Old Bailey, London, rather than proceeding with a planned sale exceeding £200 million. Similarly, Canary Wharf Group secured a financing package worth over £500 million, which included extended loans for some of its properties, demonstrating a trend toward securing additional time to manage debts rather than selling assets under pressure.

Increasing Stress and Strategic Adjustments

Bayes Business School’s report also highlighted growing stress within loan books, evidenced by more frequent breaches of loan conditions and a declining ratio of income to debt costs. High-risk loans were more commonly found among private debt funds and smaller lenders, while major banks appeared less exposed, having adopted a more cautious approach since the last major financial crisis.

Lisa Attenborough, head of debt advisory at Knight Frank, mentioned the ongoing challenges for second-tier property owners who have taken on higher leverage. These owners face tough negotiations, as banks are reluctant to lend or refinance their properties. She emphasised that while lenders are generally reluctant to take control of properties, such cooperative discussions are crucial in these trying times.