Debt Funds See Bigger Property Returns After Brexit Vote

(Bloomberg) -- Real estate debt funds are filling the gap left by banks in the U.K. after some lenders pulled out of the commercial property market and the Brexit vote caused borrowing costs to increase.

Investors from Massachusetts Mutual Life Insurance Co. to Intermediate Capital Group Plc’s ICG-Longbow unit are taking advantage of the reduced competition, which has boosted returns for real estate debt. Nationwide Building Society announced a plan earlier this month to cease commercial-property lending and some German lenders, which have advanced cheap credit for prime properties, may find it more difficult to give mortgages in the U.K. after the country voted to leave the European Union.

“Banks have definitely become more cautious,” Martin Wheeler, co-head of ICG-Longbow, said in an telephone interview. “In the run-up to the referendum vote, banks massively increased their market share, while non-bank lenders reined in their lending. That is now going into reverse.” His firm has raised 1 billion pounds ($1.2 billion) to lend.

Record-low interest rates have encouraged investors to seek returns in everything from lotteries to bingo halls as they try to beat gilt yields. ICG-Longbow is targeting annual returns of 10 percent from its new fund, which won’t lend against buildings in the City of London financial district, Wheeler said. The firm had initially planned to raise 750 million pounds and received additional capital from investors after the Brexit vote, Wheeler said.

Fixed income and real estate managers are allocating money to the debt funds, according to Anthony Shayle, head of U.K. debt at UBS Group AG’s global asset management unit. That has been “prompted by the desire to achieve subdued volatility” by investing in real estate debt rather than equity, he said.

Higher Mortgage Costs

The uncertainty caused by the referendum result has helped push up the cost of mortgages for commercial properties in the U.K. For example, a 55 percent loan-to-value mortgage for a building in good condition with secure rents has climbed to about 2.75 percent above benchmarks from 2.5 percent, Wheeler said.

At the same time, mainstream lenders have reduced the amount of credit they are willing to provide, relative to the value of properties, in a bid to protect themselves from potential value declines, he said.

German lenders accounted for 17 percent of U.K. commercial-property loans in the first half of the year. Several of them fund loans through the Pfandbrief covered-bond market. Current rules permit only properties within certain authorized countries and regions, such as the EU and European Economic Area, to be financed in this way. In the event of a so-called hard Brexit, in which Britain would be left outside the EEA, U.K. properties would no longer be eligible without rule changes.

That would create “a lot of hassle and expense for affected German banks,” Peter Cosmetatos, chief executive officer of the Commercial Real Estate Finance Council, said in an e-mail.

Falling Values

A drop in U.K. commercial-property values will accelerate in 2017, with parts of the London center seeing a much sharper decline than the average of 10 percent to 15 percent, Deutsche Bank AG’s asset-management unit said in a September report. Simon Wallace, head of alternative-asset research at the unit, said the drop could reach 30 percent.

“Banks are starting to wind down their appetite for lending against property with loan-to-value ratios falling,” Robert Noel, CEO of Land Securities Plc, the U.K.’s largest real estate investment trust, said in an interview. Their “capacity to lend is falling because of their capital-adequacy requirements. It makes it more expensive for banks to lend to real estate.”

To contact the reporter on this story: Jack Sidders in London at jsidders@bloomberg.net. To contact the editors responsible for this story: Neil Callanan at ncallanan@bloomberg.net, Andrew Blackman, Ross Larsen