Warning: Rising debt costs will impact asset pricing, says Savills lending report

The cost of borrowing for real estate has now climbed to the same level as some prime entry yields, putting some leveraged buyers - and asset pricing - under pressure.

At Savills’ 34th annual Financing Property presentation in London, the firm said leveraged buyers are now factoring in debt costs that have risen ‘sharply’ in the last 12 months, ‘which could impact pricing for some assets.’

‘The rising debt cost comes at a point in the cycle when yields are historically low, meaning that the all-in-cost of debt stands at the same level as prime entry yields for many markets across the UK and Europe’, the survey says.

‘These rates have risen sharply over the last 12 months, with investors factoring in higher debt costs into their financial models. Inevitably, for those leveraged buyers focused on income-based investments, returns are coming under pressure.’

Borrowers face being squeezed by both rising swap rates - the 5-year Sonia swap increased to 1.86% in the UK earlier this year - and lenders putting up their margins.

The European Central Bank is widely expected to start raising its minus 0.5% deposit rate as soon as later this month, to combat inflation now running in the eurozone at 8.1% (May).

Savills stressed there is still liquidity for borrowers, with over 400 ‘active’ property lenders recorded in the survey this time, up from 240 in 2018.

However, Savills added that while ‘everything is financeable’, it comes ‘at a price.’

Commenting on the Bayes UK Commercial Real Estate lending report last month, its author Dr Nicole Lux told PropertyEU that alternative lenders increasingly required higher IRRs to reflect rising risk and so were increasing margins.

Nick Harris, Savills head of UK and cross border valuation, said: ‘Lenders are likely to remain focused on asset selection, quality of sponsors, and the cashflow story. Future capex requirements are a challenge for both lenders and investors at present, with the market witnessing unprecedented levels of cost inflation, resulting in financial models coming under increased scrutiny.

‘The factors that remain in focus for many lenders are a flight to quality, concern around future obsolescence, and the cost of meeting EPC requirements, particularly in the commercial sector.

‘Lenders will likely examine rental growth prospects to support their customers in paying keen yields, with that growth arguably coming from those sectors that are short on the right stock.’

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