One of the major constraints in the property sector right now is that of securing finance. Lower mortgage approvals, tighter lending criteria, and banks’ risk aversion, have all made it more difficult to secure funds for property investment across the spectrum from home ownership to development finance. In the past couple of months, though, there’s been some evidence that the markets are thawing and finance has become easier to find. Are we all kidding ourselves? I rang a number of industry experts to find out.

In the residential mortgage market, it looks as if we may be past the worst, according to Andrew Hagger, a spokesman for the price comparison website MoneyNet. He says, “Mortgage providers are beginning to show a bit more appetite,” since negative equity is less of a concern now that the house price decline appears to be slowing. He’s also seen a lot more advertising in recent weeks, with promoted products including one from the Halifax which offers to pay council tax for half a year for first time buyers, and a fee-free offer from Alliance & Leicester.

However, loan to value ratios are still restrictive. Hagger says, “Unless you’ve got a big deposit to put down you’re still paying a big premium on the interest rate.” While in the boom, the income multiple was the main focus, it’s now the size of the deposit which is the main focus of both banks and buyers. “People are saying I need to put down as much as I can, rather than I need to borrow as much as I can,” he says. Lending criteria appear to be loosening a little, with more mortgages available for higher LTVs. Pricing for 80-85 per cent LTV mortgages is also now getting more competitive, though buyers without a large deposit will still pay a premium. Hagger doesn’t believe we’re likely to see 100 per cent mortgages return. If they do, he thinks they will probably be specialist products, most likely on longer term fixed rates with much stricter criteria and tight customer targeting.


8000 fewer mortgage products than two years ago

Darren Cook, at Moneyfacts, tracks the mortgage market and has detailed figures on the numbers of products available. There were 9549 mortgage products in the market on 31 July 2007, at the top of the boom, and that’s fallen to just 1267 now. He believes the proliferation of products during 2007 was due to the highly competitive nature of the market. “It was such a free-for-all to get the business,” he says, “lenders had to be innovative with their product ranges.” Now, lenders are less keen to take on new business, and many products have disappeared.

However, he believes the market has now stabilised; the number of products hasn’t fallen for the last one-and-a-half months. “Lenders have had time to streamline their product ranges,” he says, so they may not need to do any further pruning. Besides, six rate cuts in a row meant that lenders had to withdraw and reprice products to maintain their margins. Now interest rates appear to have settled at 0.5 per cent, the banks can plan their product ranges better.

There’s no doubt that mortgages are now a very profitable business for the banks – which they probably weren’t at the top of the boom. Andrew Hagger says that on trackers, the margin that banks charge over base rates has increased to 2.5 to three per cent and can be as high as four. Right now, he believes fixes are the best option for homeowners.

“You’ll be paying over the odds on what you’d pay on variable in the very short term, but in a year or two you’ll probably be doing better,” he says.

The fact that many fixes are at rates significantly above SVR – and fixed term savings products too are available at well over three per cent – suggests that bank treasuries are expecting rates to rise significantly over the medium term.


Sub-prime mortgages

While increased availability of mortgages may be good news for most, those with an impaired credit history may not benefit. While the sub-prime sector isn’t completely dead, Darren Cook says that there are only eight products now available in the market, and all of them charge eight to nine per cent interest – a big risk premium. “There were thousands of subprime mortgages a couple of years ago”, he says, many of which have now reverted to LIBOR plus a margin (rather than SVR).

“That market’s gone.”

In the rest of the market, it looks as if there’s been a shift away from two-year fixes to longer term fixed rates. That goes along with a move from some banks to cut brokers out and focus on lending through the branch system. The Woolwich and other lenders have been operating dual pricing, with mortgages for direct customers available at a better rate than through brokers. Darren Cook says the strategy “let them turn the taps on and off when it suited them with the branch business” – but it also made brokers uncompetitive. That could be bad news for these banks in an upturn. If their branch networks aren’t able to handle new business, and they’ve frozen the brokers out, they could lose market share.

HSBC’s joint venture with broker John Charcol shows that at least one bank is aware of the importance of maintaining its distribution chain – but not all banks are being that smart.


Buy to let – all but moribund

On the buy-to-let side the market is more restrictive. Andrew Hagger says, “The number of products has dried up, the LTV has really been tightened up and on the whole it’s been hit harder than residential owner occupier.” He believes most lenders see it as a more specialised area, and have been worried about the increasing number of amateur landlords didn’t have much leeway if anything went wrong.

Some lenders – though not all – were demanding that 125 per cent of the mortgage was covered by rental income. “That was a smart move,” Hagger says, “but lenders who did that were in the minority.” More specialist lenders understood the market – but some of the mainstream banks, he thinks, got into the market without understanding it so well and have now withdrawn their products. Darren Cook has the numbers on this market and they make sombre reading. There were nearly 3500 buy-to-let products in July 2007; now there are only 224, less than ten per cent of the previous total. Some providers, like Bradford & Bingley and Northern Rock, have closed their doors completely. “If you have an existing buy-to-let mortgage the products just aren’t available to remortgage.”

Unlike residential mortgages, BTL mortgages are generally priced according to risk, so that the mortgage will revert to base rate plus a margin, rather than the standard variable rate. There may be unpleasant surprises for some borrowers. Looking at the terms of the products available, there are no LTVs above 80 per cent, and only four fixed rate BTL mortgages available at that level. LTV of 75 per cent and below has become normal.

So much for products; what is actually happening in the market? The Council of Mortgage Lenders’ figures show mortgage approvals in March 2009 at 46,464. That’s below 61,578 in March 2008 and way below the exceptional 133,194 in March 2007. But the decline is slowing from 54 per cent to 25 per cent.


Commercial – Little new lending

Mortgages for residential property are relatively easy to analyse. Commercial property lending is rather different – as Darren Cook points out, “It’s difficult to track prices on the commercial side as a lot of it is negotiable.” However, the story is similar to what we’ve seen on the residential side. Colliers CRE says in its Property Snapshot for April 2009 that, “Property lending remains weak with few banks lending,” and forecasts that, “the lending market will remain unsupportive of new large debt-backed investment in property assets throughout 2009 and into 2010.”

Pressure on loan to value ratios is increasing, with banks offering LTVs of just 40-45 per cent in many cases, and only where they already have a strong relationship with the borrower. Ed Stansfield, an analyst at Capital Economics says, “The banks seem to be funding nothing unless they really have to. Development finance is to all intents and purposes unavailable at the moment.” The share of the banks’ loan books that is lent to property is at a record high and he believes most banks would like to see that exposure reduced, so there is likely to be little new lending in the short term.


Who is lending and how?

Tony Edgley, MD of corporate finance at Jones Lang Lasalle says, “There are probably between 12 and 15 lending institutions in the UK who – for the right deal – are in the market and have about £50m per transaction.” But they are being selective; both assets and borrowers have to come up to scratch. And anything more than £75m has to be syndicated. This borrowing is, “a very specialised sliver of the market,” Edgley warns.

Just as mortgage margins have widened, the commercial property business has become highly profitable for the banks. Rates for low risk, high quality assets – the only ones the banks will consider – are standing at two per cent above five year swap rates, Edgley says. With swaps currently at 3.2 per cent, that means borrowers are paying 5.2 per cent for 60 per cent loan to value, plus a one per cent minimum arrangement fee and possibly an exit fee as well. With base rates at half a per cent, that makes property lending a great business – as Edgley says, “If I can get six per cent on only 60 per cent of the value, on a risk adjusted basis that’s a very good return on my capital.”

Equity rights issues by major players such as Segro, Land Securities and Hammerson show that equity investors now have an appetite for risk. Ed Stansfield says, “That may reflect a sense that the quoted stocks had been rather oversold, with extreme discounts to net assets,” says Ed Stansfield. It’s enabled many of the larger investment companies and developers to repair their balance sheets. But Tony Edgley thinks larger investors are increasingly preferring debt. With six per cent available on a loan, while equity yields are around the seven to nine per cent on a significantly higher risk, there’s no equity risk premium priced in any more.

In any case, he points out that the entire market capitalisation of the FTSE property sector is only half that of Tesco. “That is the extent of the value destruction that has happened.” The property sector across Europe is only 2.5 per cent funded by publicly quoted equity, so though it’s good to see shareholders displaying their confidence in the sector, this won’t solve the capital constraints currently facing developers. And though it’s possible for existing quoted companies to raise money, he can’t see new companies coming to the stock market unless they have a very convincing story and managers with a track record and reputation. Besides, Edgley says, “You need the power of debt. If the debt is not there, then the equity is moribund.” So it seems that capital is a constraint on the market across the sector.

Whatever the proposed development or purchase, funds are difficult to source and banks are cherry-picking the clients they want. It’s interesting that despite the high margins now available to lenders, no banks yet seem to be taking advantage of the chance to make a land grab for market share – though Santander has been dipping its toes into commercial property.

However, it does seem that we’ve reached the bottom of the trough – at least as far as the availability of finance is concerned. What remains to be seen is just how fast markets will recover – and on that, the jury is still out.