Banks hold large resi projects that are under water, but development cash is scarce Schemes bought from 2005 onwards are probably in negative equity
Three years after the start of the credit crunch, lenders are still sitting on a vast book of residential property loans – many of which are under water.
According to our research, London has 114 large residential schemes – large means the scheme contains 250 or more private flats – totalling 148,000 flats, which are either in for planning, consented and not on site, refused, at appeal, or part of a masterplan.
In many cases, these large projects will almost certainly include a tower structure, which is expensive to build.
Many of these projects are backed by loans from Lloyds Banking Group, Royal Bank of Scotland or Nama, with the balance coming from other financial institutions, local authorities or housing associations.
There are investors and developers willing to buy these schemes, but they need new finance to do so. The handful of banks that are lending on property are not keen to back such schemes because the time they take up to build ties up their greatly reduced property lending allocation.
40% equity required
If a developer does manage to line up funding, it still needs to produce at least 40% equity, and be prepared to pay 6% for the loan, as well as hefty fees on the way in and out.
Private equity is an alternative. Companies such as Orion, AREA, Blackstone, Graphite and Varde are now teaming up with developers.
However, while this type of finance might be easier to access than bank funding, private equity funding comes at a much higher price, which restricts its widespread use.
The only solution for most of these larger sites is for new developers to come in with fresh equity to carry out construction in a joint venture with the existing lender, which can take what it is owed when the finished units are sold.
This solution allows the bank to avoid taking further instant writedowns on the loans. However, the lender may have to supply additional debt to encourage developers to take on the schemes.
In many cases, banks prefer to work with existing borrowers for as long as possible because of the borrower’s intimate knowledge of the scheme. However, a bank will at some point abandon a borrower who remains unwilling to accept that the scheme is under distress.
When no other solutions are at hand and a sale is required, agents are being put in touch with borrowers, who are told by their bank to “appoint an agent or we will”. If they won’t co-operate, a fixed charge or LPA receiver is appointed.
This seems the most cost- effective solution: expensive administrations on smaller projects seem to be becoming a thing of the past as costs are kept to a minimum.
We are seeing some encouraging signs of appetite from residential specialists. Some housing associations are back spending cash they have been sitting on after a dry spell of residential stock delivery.
Contractors, many of whom have been sitting on the large cash piles they made from the boom, are developing in their own right and collecting a contractor’s margin as well as a development profit.
Developers lead the way
Private developers in many cases are leading the way again, particularly on sites without planning. House builders are ready to build, but most don’t seem to have the cash to match their ambition.
However, there are some very early indications of a slight cooling in the residential sales market. Although investor demand from Hong Kong, Malaysia and Singapore for new London homes is strong, buyers are becoming more discerning about location.
Does this mean that demand is starting to dry up?
Deals are still going through, but vendors need to be patient and be ready to supply every piece of information on a property at the point of sale.
Vendors must vet potential buyers by asking them whether, for example, they have the cash to complete the transaction, because without it there is no way they will qualify for development finance .
With the exception of prime central London, I believe that anything bought from 2005 onwards, whether it is a site, with or without planning, or a buy-to-let, is probably still under water. A policy of low interest rates is still providing a protective veil for many, but this will not last forever.
However, with eurozone turmoil and unrest in the Middle East, prime or well-located residential property in London is still probably one of the safest places to put your money.
