Savills opened its annual Financing Property presentations today (9 June 2010) in the City of London addressing lenders on whether the market is heading ‘Back to Normality?’. The international real estate advisor reported that, whilst macro economic issues such as a new coalition, cutting the deficit, direction of inflation and the state of the Eurozone are creating uncertainty, interbank market stability has returned and debt finance is still available. Banks are under pressure to clean up loan books, but the cost of unwinding existing fixed interest instruments known as swaps* is an important reason preventing a flood of property being released onto the market.

According to Savills, the total cost of unwinding existing swaps could be as much as £10bn, given that De Montfort University research shows that 57% of the circa £250bn existing UK loan book at 31 December 2009 has an interest rate hedge in place. The firm observes that the cost of unwinding the swap takes priority ranking alongside senior debt if properties are to be sold free of existing debt.

William Newsom, Savills UK head of valuation, says: “Interest rate swaps are a perfectly proper risk management tool and 92% of banks continue to insist on it. In fact it usually points to stability in the market because the rate of interest payable is known for a period to come. However, before the credit crunch, nobody anticipated the rate at which interest rates fell. The good news is that whilst banks are cautious, they continue to focus on working with core customers whilst new lending organisations are emerging, attracted to the market by the favourable lending conditions.”

Savills, in referring to a report by De Montfort University stating that over the time period 2010 to 2012 53% of total loan books are due to mature at £120.7bn, suggests that lenders will continue to focus on restructuring loans with core customers and refinancing where possible. The firm notes that for lenders of new debt the margin between property yields and the cost of money currently is a substantial 5%. New entrants to the market in the past 12 months include Aldermore, Bank of China, BSI, M&G, Royal Bank of Canada, Standard Bank and Unity Bank, often for smaller lot sizes. Furthermore, this year has seen six active players in the development finance arena for the very best residential or fully pre-let commercial schemes. They include Barclays/Barclays Wealth, Close Property Finance, Investec, HSBC/HSBC Private Bank, Lloyds Banking Group, RBS/Nat West/Coutts with an additional 10 other lenders who may provide finance ‘in the right circumstances’.

In terms of property product in which to invest, Savills research indicates that markets appear to be returning to a more stable state with the average yield gap widening between primary and secondary cities by as much as 222 bps. However, Savills states that the threat of public sector cuts/rationalisation could create a ‘tale of two cities’ as those cities with a reliance on public sector activity experience a fall in public sector demand. Identifying these cities could therefore be key to risk averse investors, for example those locations with a critical mass in private sector jobs and a lack of supply pipeline such as London, Manchester and Edinburgh could see further office rental growth - London’s West End is forecast at over 8% in 2010. Meanwhile other sectors such as logistics could look more attractive again given its limited development pipeline, typically long term leases and a lack of volatility.

Mat Oakley, head of commercial research, adds: “Debt worries have moved from personal to sovereign with speculation mounting as to how the government will deal with the issue of public spending. Stock market volatility will continue to attract investors to property and the key to their success will be identifying areas of opportunity such as core markets, mid rented schemes and under supplied areas.”

In the residential sector, Savills research shows mortgage availability has been slow to improve and lending remains weak. Low loan to value ratios have created a gap between the purchasing ability of those with and without equity, that has contributed to a North South divide and constrained transaction levels. Because house builders have by and large solved their immediate funding issues and worked through their excess stock, they are again looking for development opportunities. However they are being very selective in what they take on, preferring smaller less risky developments in equity rich markets, in the knowledge that achievable rates of sale are still limited.

Lucian Cook says: "Looking forward, the residential development market not only has to contend with limited availability of development finance and potentially volatile house prices, but also change in the planning system and an increased regulatory burden, which indicates a slow and gradual recovery in development activity, initially centred on London and the South East. This combination of limited finance, a gradual housing market recovery and planning change will mean that viability will replace volume as the watchword."

For further information, please contact:

William Newsom, Savills
+44 (0) 20 7409 8780

Mat Oakley, Savills
+44 (0) 20 7409 8781

Lucian Cook, Savills
+44 (0) 20 7016 3837

Victoria Cambridge, Savills press office
+44 (0) 20 7409 8940

Editors Notes:

A swap involves agreeing a fixed rate for a period of time as distinct from taking a floating rate loan. If a loan is to be restructured and in the intervening period the cost of money has decreased, which has been the case, then the holder of the swap needs to be compensated for the difference between what he currently receives and the current market level.