Lending to UK commercial property is about to get more scarce, and defaults on existing loans are set to rise — but changes to the lending market and the growth of nonbanking loan books over the last decade means nobody really knows by how much.

While UK banks' loan exposure to CRE is generally low, there are concerns about nonbank lending. The last Bayes Business School UK lending survey reported that nonbank lending had increased for 15 successive years to 2022, reaching 38% of new lending in 2022. Debt funds account for 25%.

Oxford Economics noted that “much of the lending falls outside of regulatory oversight, so the risks are much more opaque”.

“Recent bank funding turmoil will lead to additional tightening in credit conditions for commercial real estate at a time when the asset class is already reeling from higher debt costs, an inadequate risk premium, and emerging refinancing distress," it said in a report on the sector. "This has prompted us to downgrade our baseline forecast for UK CRE values over 2023-2024,” Oxford Economics' bulletin said.

Off the back of a 10% fall in UK all-property capital values, on top of an 11% correction last year, Oxford expected some borrowers to be under extreme pressure.

“We know that commercial real estate default risk increases as interest rates rise, as the risk premium for CRE loans widen, and as loan to value ratios move higher. Bayes reported in its 2021 survey that debt funds issued 58% of loans at an LTV of 60% or above, with 22% above a 70% LTV — much higher than the wider market where LTVs have been restrained to generally around 50% on average.

“In our view, this is an unwelcome mix during the current period of bank funding turmoil and could exacerbate capital value decline,” it concluded.