Lucy Barrett - Managing Director of Aria Finance
Why is there a lack of competition at the lower and of the commercial property sector? And what can be done about it?
A few weeks ago, a new client approached us, looking to purchase a commercial premises from a bookmaker. The bookmaker wanted to offload the property, presumably to free up cashflow, and to rent it back from the new owner - our new client.
The loan size was fairly small, less than £150,000, and the client owned no other commercial property. Hence, in the eyes of a lender, they would be deemed inexperienced. Given the transaction size and the borrower's lack of experience, you would expect them to have to pay a rate premium. I was shocked when they were quoted 9.5%.
To put that into perspective, recently we've been able to achieve rates in the region of 6-7% for clients borrowing £500,000 or more.
I know rates have gone up significantly over the past 12 months, but there is no way our new client could make this deal work without charging eye-wateringly high (and completely unrealistic) rents.
Of course, lenders have the right to charge what they want, but this is becoming a worrying trend. We are seeing fewer and fewer lenders willing to operate in this end of the market, with the high-street banks having either rigid criteria that elicit no appetite or loan-to-values sub-50%.
All markets need strong competition to function properly, but competition in the commercial mortgage market is distorted at the best moment. That can only be bad for borrowers.
MINIMUM LOAN SIZES
The two obvious questions are: why the lack of competition at the lower end of the commercial investment market; and what can be done about it?
To answer the first question, a 'Bigger is better' mentality has emerged in the sector over the past few years. A lot of lenders have introduced minimum loan sizes, while others have made it clear would prefer one £1m transaction over 10 at £100,000.
Part of the reason is a desire to manage costs and service levels. But there is also a desire to focus on easy, more transactional business that for banks does not require them to hold so much capital. Again, that is a lender's prerogative.
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We also get the sense from lenders that larger cases are often viewed as being of higher credit quality. This may be the case sometimes, but not always. The problem with that mindset is that it doesn't take into account regional differences with regard to property values.
Lenders that only chase big-ticket loans in the Southeast also risk being overexposed in certain regions and their book being insufficiently diversified.
The main reason the commercial market does not have the same level of competition as its residential and buy-to-let (BTL) counterparts is that it doesn’t have a thriving core of non-bank lenders. These lenders naturally tend to operate in niche parts of the market where mainstream lenders refuse to tread.
However, the non-bank lenders that have sprung up since the financial crisis have shown a reluctance to enter the commercial mortgage market. But why? Do they not think there is a genuine opportunity to write good business in the commercial mortgage space? A more likely explanation is that the commercial mortgage is inherently more complicated and indeed riskier than residential or buy-to-let lending. As the path has rarely been trodden, the success stories can therefore not be seen.
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After all, most businesses don’t succeed. In fact, research by Fundsquire, a global start-up funding network, suggests 60% of small businesses fail within the first three years. According to Government figures, there were 327,000 “business deaths” in 2021 alone.
However, that risk can be mitigated by employing the right people, developing a strong proposition and installing the correct checks and balances at the outset.
There is plenty of property in strong locations, being purchased by people who have a good business eye and often decent financial resources, not to mention the assets rented to well-performing businesses in the first instance. Even then, non-bank lenders still have to convince their funders that the rewards outweigh the additional risk they would be taking on.
The funding for a non-bank lender to enter this space is clearly somewhat more complex, without the benefit of the securitisation market, which its buy-to-let counterparty has enjoyed for a long time with regular transactions. It will take far more creative structuring and a good business case where a lender can prove they have the expertise to manage this.
Challenging it may be, but from my experience, there is enough demand at the lower end of the market to make it worthwhile for any lender willing to make the leap. If those lenders are reading this and they want a broker’s perspective on cracking this end of the commercial market, my door is open.
