UK real estate transactions being undertaken by GCC investors which we commonly hear about include the acquisition of high end residential property (Chelsea and Knightsbridge) and trophy assets (such as Harrods and the Shard).
There is another group of GCC investors which we hear less about, family offices and asset managers. These investors are also investing in UK real estate, focusing on income producing commercial real estate assets. Such investments are primarily located in non-prime areas and are financed using senior debt from bank and non-bank lenders.
This article provides an overview of the trends we have seen over the last 18 months which are applicable to these investors.
The cash-on-cash return requirements of the GCC family offices and asset managers have not significantly changed over the past 18 months, with the expected investor returns remaining in the range of 6-8%.
Such high yields are however becoming increasingly difficult to achieve as a result of a number of key factors including an increase in both the cost of raising finance (see below Interest rates bench marked to Libor) and property values.
In order for such investors to maintain their expected rate of returns they are having to move up the risk curve. Such risk entails acquiring real estate assets in non-core cities (taking on location risk), acquiring real assets with weighted average unexpired lease terms (WAULTs) of less than ten years (taking on lease re-gearing risk) and/or taking on some development risk.
In the current climate there are a limited number of properties available yielding 6-8% that are let with WAULTs exceeding ten years. Many investors are choosing to hold property (instead of selling) because of the concern they will not be able to recycle the cash into new assets at an attractive yield putting a further squeeze on supply.
In order to enhance equity returns and spread risk the purchase price of commercial real estate assets is often funded in part by borrowing money. Senior commercial real estate lending has remained strong and at par with the 2016 levels.
Loan to Value (LTV)
LTV ratios have remained consistent throughout the last 18 months. Maximum LTV ratios for senior loans currently sit at a sensible rate of approximately 60%. The LTV ratio will be lower where the reversionary value of the real estate asset (being value of asset at the date the loan term expires) falls below the initial purchase price (this can occur where a tenant is over paying under its lease which has a 8-10 year term left, any re-gearing of that lease will likely result in lower rental income which in turn will impact property value).
Interest Rate Cover (IRC)
The other financial covenant commonly tested in loans secured against commercial real estate is the ICR (the ratio of annual rental income to annual interest payments). ICR ratios have also held consistent at between 230 – 260%.