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 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 had to pay a rate premium. I was shocked when they were quoted 9.5%.
A ‘Bigger is better’ mentality has emerged
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%.
The non-bank lenders that have sprung up since the financial crisis have shown a reluctance to enter the commercial mortgage market
All markets need strong competition to function properly, but competition in the commercial mortgage market is distorted at best at the moment. That can be only 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 this sector over the past few years. A lot of lenders have introduced minimum loan sizes, while others have made it clear they would prefer one £1m transaction over 10 at £100,000.
The funding for a non-bank lender to enter this space is clearly more complex
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.
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 it doesn’t take into account regional differences with regard to property values.
Lenders that chase only big-ticket loans in the Southeast also risk being overexposed in certain regions and their book being insufficiently diversified.
There is enough demand at the lower end of the market to make it worthwhile for any lender willing to take the leap
The main reason the commercial market does not have the same level of competition as its residential and buy-to-let (BTL) counterparts is 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 think there is not a genuine opportunity to write good business in this space?
Path less trodden
A more likely explanation is that the commercial mortgage is inherently more complicated and indeed riskier than residential or BTL lending. As the path has rarely been trodden, the success stories cannot be seen.
There is a desire to focus on easy, more transactional business that for banks does not require them to hold so much capital
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 with 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 have to convince their funders that the rewards outweigh the additional risk they would be taking on.
All markets need strong competition to function properly, but competition in the commercial mortgage market is distorted at best
The funding for a non-bank lender to enter this space is clearly more complex, without the benefit of the securitisation market, which its BTL counterpart has enjoyed for a long time with regular transactions. It will take far more creative structuring and a good business case for a lender to prove it has 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 take 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.
Lucy Barrett is managing director of Aria Finance
This article featured in the May 2023 edition of MS.
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