• Borrowing costs are expected to skyrocket over the next 5 years
  • Some companies are already abandoning their fundraising plans
  • Rents under pressure as tenants reduce their real estate needs

LONDON, Oct 21 (Reuters) – Owners of Britain’s biggest shopping malls, skyscrapers and industrial hubs are facing rising borrowing costs and a recession that could push prices down by as much as a fifth, forcing lenders and investors to reassess their appetite for commercial real estate.

Developed economies around the world are grappling with the profound consequences of the end of years of ultra-loose monetary policy, which kept asset prices high and the cost of debt low.

So far, nowhere has the shock of this reversal hit harder than in Britain, where clashes between policymakers over how to revive growth and halt inflation have sparked a dramatic revaluation sterling money markets.

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

Data from MSCI, which tracks monthly changes in 1,794 properties valued at around 37 billion pounds ($42 billion), showed values ​​fell 2.6% in September, the biggest monthly drop since July. 2016, the month after Britain voted to leave the European Union.

Commercial real estate investors like real estate investment trusts (REITs) rely on the possibility of earning more in rents and profits on sales than they pay out in expenses, including debt and equity costs.

Indicators like Land Securities (LAND.L), British Land (BLND.L) and Hammerson (HMSO.L) pushed the major refinance past an expected mid-2023 peak in the Bank’s benchmark rate of England, according to tax returns.

But good financial management is only a challenge, as the expense of labour, fuel and basic commodities also increase the risk of cash-strapped tenants returning their keys.

Although less exposed to subprime mortgages than before the global financial crisis of 2007-2008, banks are already on high alert for breaches of lending conditions linked to an asset’s market value or rental income relative to to debt secured on it, sources said.

If these conditions, or covenants, are not met, investors may need to refinance sooner than expected, at higher rates. Goldman Sachs analysts predict that the gross financial costs of the UK listed property companies they cover could rise by 75% over the next five years.

James Liddiment, managing director of the Real Estate Advisory Group at Kroll, said commercial property prices were already being hit by rising borrowing rates, which was a fundamental cost to occupiers and investors.

“Given the likely number of people affected and the level to which rates are expected to rise, lenders may be forced to accept covenant waivers in an effort to stabilize loan portfolios,” he told Reuters. .

UK REITs use less leverage today than before the financial crisis. But as property values ​​fall, average loan-to-value ratios have climbed to 28% from 23% at the start of the year, according to Zachary Gauge, head of real estate research at UBS.

5-year sterling interest rate swap


Worries over financing costs follow years of worry over rents at some REITs, as the pandemic has emptied offices, shops, pubs and restaurants, reducing demand for business space.

According to Remit Consulting, office occupancy rates in the UK have been around 30% in recent weeks, compared to an estimated average of 80% before the pandemic.

Vacancy rates for leisure and retail properties also remain above pre-pandemic levels, according to figures from the Local Data Company, at 10.6% and 15.4% respectively. Footfall in UK retail destinations is down around 15% on average in 2022 compared to 2019, according to data from Springboard.

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

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

Some users are cutting spending to reduce costs and energy consumption, which should further squeeze rental income for real estate companies.

HSBC (HSBA.L) told staff this month that it was reducing its office space worldwide by around 40% from 2019 levels.

The lender could abandon its iconic Canary Wharf skyscraper in London as part of a wider review and, in the meantime, it is consolidating staff on fewer floors in the 45-storey tower, reducing the space occupied by 25%.

Marks and Spencer (MKS.L) is accelerating plans to close 67 “full line” department stores over five years, dealing a blow to its owners and neighboring businesses.

Uniform Business Rates (UBR), a tax levied on commercial property, is set to jump £3billion next April, the biggest annual jump since 1991, after inflation hit 10.1% in September , the month in which the rates for the following year are set.

“…more business failures and store closures will happen unless UBR is frozen again,” said Jerry Schurder, commercial rate policy manager at Gerald Eve.

The $2.2 billion LXi REIT dropped a planned sale of new shares expected to be priced above its net asset value (NAV) to back a £500 million acquisition of 18 Sainsbury’s stores (SBRY.L).

But the government’s Sept. 23 announcement of its ill-fated growth plan sent the stock 11% below net asset value, preventing the company from raising equity at a price acceptable to investors, it said. said a person familiar with the deal.

Cyrus Ardalan, chairman of LX, said that given “the challenging macroeconomic backdrop”, investors could “take comfort” in LXI’s resilient and diversified portfolio of long-term, inflation-protected assets, and said highlighted its 100% fixed or capped debt.

The stock market is also signaling growing investor caution towards UK commercial property, with an index of 15 UK REITs down 44% so far in 2022 (.TRXFLDGBPREIC) from a 9.8% decline in the FTSE 350 (.FTLC).

Some international investors are also reporting concerns from UK developers over their ability to fund construction.

“The developer says we would like to sell it now, or we’re more open to selling it now, and so much so that we’re willing to give away some (…) of the developer’s profit in order to keep us going. before,” said Martin Zdravkov, senior portfolio manager at German asset manager DWS.

UK REIT index vs 30 year gilt yield

($1 = 0.8906 pounds)

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Editing by Tomasz Janowski

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Elizabeth Howcroft

Thomson Reuters

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