Lending to UK commercial property held up in the second half of 2022 compared to 2021 in spite of the sharp spike in interest rates, as borrowers tried to refinance ahead of further expected rate rises.

A total of £24.9B of real estate debt was originated in the second half of the year compared to £23.7B in the first half, the latest Bayes UK Commercial Real Estate Lending Report showed, with the £48.6B issued throughout the year only 2% down on 2021 despite turmoil in financial markets.

The second half of 2022 was dominated by the Bank of England's increase in interest rates, leaving many real estate investors worried about the incremental cost of financing, Bayes said. This resulted in increased refinancing activity in Q4 2022. Borrowers refinanced early rather than waiting until 2023 or extending loans into 2024.

Across the year, 65% of new debt originated was for refinancing existing loans. The historical average is about 50%.

“We are definitely seeing that large institutional borrowers are rushing to negotiate the best debt deals,” Bayes Business School senior research fellow Nicole Lux said. “As long as the income remains stable, new asset valuations are holding up and borrowers are negotiating their refinancing as early as possible.”

As uncertainty took hold in the market, lenders became more conservative. Margins for prime office loans moved out by 0.16% to 2.7%, but loan margins for secondary offices moved by 0.46% to 3.87%. The largest movement was seen for secondary industrial property, which moved by 0.69% to 3.58%.

In addition to increasing lending margins, lenders also lowered the loan amounts on new loans. The average loan-to-value ratio for a prime office loan is now 54.8%. In 2021, it was still 56.8%. Similar movements were observed for all other property types.

The report also found that loan defaults and loans in breach of covenants increased in 2022. Loans in default rose from £2.4B to £2.7B, while loans in breach of covenant hit £4.6B, meaning £7.3B of loans are facing some form of financial stress.

Though that represents an increase, it is still far less than in the wake of the Global Financial Crisis, when more than £30B of loans were in default or in breach of covenant.

The report pointed out that the apex of loan defaults during the Great Financial Crisis came in 2011-2012, five years after the 2007 peak in values and three years after the 2009 trough.

It also gave an indication about where stress is concentrated in the system today. While the average of loans in default was 3.5%, 12% of the £35B of loans held by other lenders, which includes debt funds, were in default at the end of 2022.