It says it all when the Edinburgh office of a large national firm of agents is asked to comment on funding, it declines and replies that there “isn’t anything for us to say”.
The funding landscape is bleak. Development funding has become an endangered species and the much talked about alternative sources of funding are, in fact, on closer inspection a mythical beast (see Alternative funding souces, below).
The same is true in Edinburgh, in Scotland, and in the rest of the UK. But as Alasdair Ramsey, partner in charge of Drivers Jonas Deloitte’s Scotland office, says: “The further north you move there is concern about the some of the risks deemed to be in our markets and that is the principal feature restricting funding.”
For Edinburgh, that brings an interesting conundrum. DTZ estimates that grade-A office supply at current take-up rates will last just over two years, down from six years’ worth of supply in Q3 2009. While take-up is hardly setting the world on fire, once the Brewer Dolphin deal at Atria is stripped out clearly development has to come from somewhere. So who might fund it?
For some the banks are still the only answer, but that field has narrowed considerably. Clydesdale Bank announced at the end of last month that, along with sister company Yorkshire Bank, it was axing 1,400 jobs. It is also moving out of commercial property. Owner NAB will move the £6.2bn property loan book onto its balance sheet, with an orderly run-down carried out over the next six years. The industry is still digesting quite what that means on the ground in Scotland.
Some say Clydesdale Bank was not a big property player and probably came to the commercial property market quite late.
Others believe it is a bigger deal. “It’s something we’ve spoken about internally over the last couple of months, but losing Clydesdale is not the best for the banking industry,” says one.
Fiona Morton, chairman of Ryden, says the outcome of NAB’s review was not a surprise. “Clydesdale Bank and Yorkshire Bank had to go back to basics to clean up the UK business and ultimately make it sustainable and saleable. The outcome will be no new commercial property lending as they work down their existing book leading to portfolio loan sales as is happening at Royal Bank of Scotland, Anglo Irish and Lloyds Banking Group.”
The latter, encompassing Halifax Bank of Scotland, has indeed been working out its portfolio. John McWilliam, head of real estate in Scotland at Lloyds Banking Group, says HBOS was particularly heavy in commercial property and sorting that out has been a “real challenge and continues to be a real challenge for Lloyds Banking group”.
“That overhang, coupled with the gloomy economic situation, makes it particularly challenging and for me, I am cautious with a degree of optimism,” he says, adding: “we still have a stated appetite [for commercial property] things are taking a bit more time and I’m comfortable with the level of work going on but I’m not bowled over by the rush.”
McWilliam explains that at a time when the government is challenging banks to shrink their balance sheets, he is being challenged with increasing their core book. “I do want to grow it,” he says. He points to the Ocean Terminal deal in Leith where the bank funded the purchase of the shopping centre by Resolution Property at the beginning of the year. “It was a sensible deal, at a sensible loan to value, and a sensible price.” Sensible, it seems, is a key word here.
Some development finance is on the cards, but the caveat to that is all too familiar. “We are doing a bit of development finance with customers we’ve already got a relationship with,” says McWilliam, adding “but spec development is off the table, even prelet and presold. If there’s an established operator banking with us, or someone else with a track record and a balance sheet we can see, then we’d conservatively look at prelet, but we would want the whole lot gone.”
He declines to quote margins but says that it is looking at a 60% loan to cost, and a 1% bank fee. “I understand you might be disappointed if you were looking at the business done in 2007-2008, but personally I am quite comfortable with the more conservative outlook, it’s the best thing for UK plc,” he adds.
But what is best for the country as a whole might be a difficult pill to swallow at a local level. Tom Fulton, head of investments at Colliers International in Scotland, believes that without the finance to provide the next wave of stock in both Edinburgh and Scotland, it could miss out. “There are a few requirements out there which are footloose and Scotland may lose out because other cities have the good-quality grade-A stock available,” he says. “We’ve seen a number of big occupiers move and take advantage of good incentives but who is now going to take the plunge and build large-scale grade-A?” he questions.
Fulton would like to see Scottish Enterprise take the reigns and pump prime buildings in the centre. A study is underway, he says, looking at the scarcity of grade-A supply and if there is a need for government to assist.
But there is still the real possibility that distressed assets could come flooding back onto the market this year. Ryden’s Morton believes it will continue be a slow, painful process of deleveraging, which will continue for a “very long time as investors lose their money and lenders do more write-offs on the legacy loans”.
Others believe things may come into focus much more quickly and sharply. Colliers’ Fulton says: “A lot of people gained four- or five-year facilities back in 2006 and 2007 they’ve since got one- and two-year extensions and they are all now coming to fruition.” He adds: “The banks had taken a position on these assets but things have not got better and many are now going to have to crystallise their losses.”
Some will recapitalise but others will be looking at significant losses, with Fulton pointing to situations where properties have been sold at two-tenths of their original value. “I think the banks will be taking substantial losses. Now is the time we are going to see stock coming to market loan books will be sold in advance of that and in another six months the properties will come out.”
Suddenly the fate of Clysdale Bank and its loan book seems altogether more interesting.
In the shadow of devolution
The prospect of a devolved Scotland has started to cast a shadow over finance in Scotland. Already a handful of UK institutions have raised concerns to local agents including Tom Fulton, head of investments at Colliers International in Scotland. He adds that the uncertainty is the killer: “If we become independent I don’t think it will change anything dramatically – we are too intertwined with the UK market.” Fulton says ultimately a devolved Scotland could mean initiatives that benefit investors such as tax incentives or rating-based bonuses. But until the fate of Holyrood is resolved, it seems some UK institutions may opt to keep their money south of the border.
Alternative funding sources
• Contractors
Could the contractors provide a much-needed stop-gap and nab themselves a job in the process? Property players say they have not seen a huge number put their hands in their pockets but one or two have been looking at joint ventures with institutions. But with few contractors well funded enough to take this step it is unlikely to be a universal panacea.
• The public sector
Over the past few years, the private sector has looked to the public sector to help get things going. Property pundits are now hoping development will be one of those things. But with austerity measures biting hard – and local experts believe they will bite hardest in Scotland – it might be a hard sell to convince the public sector it should help get development off the ground. One solution would be for the government to look at lease guarantees, using its covenant to ensure an institution can fund a development. However, that mechanism has been used in Wales under the Welsh Investment Strategic Partnership and had attracted widespread criticism for getting involved in the juiciest schemes many thought the private sector could manage.
• TIFs
Tax increment financing
TIFs could get an extension at Glasgow’s Buchanan Street’s off the ground, but at what price? Rival shopping centre owner Ivanhoe Cambridge threatened legal action over what it called an “illegal public subsidy”. Also, many say that borrowing on future revenues on rates is fine when things are improving, but when the economy is in tatters and the scheme you are borrowing against already has some of the highest rents around, it is a risky strategy.
• Banks
John McWilliam, head of real estate at Lloyds Banking Group in Scotland, believes that how banks deal with lending is one of the biggest challenges in property for the next two to three years. He believes the financial services needs to solve this one itself and come up with a methodology for unlocking the funding to the market. “The loan needs to end up in the right place and on the right balance sheet, banks can’t hold 15- to 20-year assets,” he says. The appetite for even long-term solid cash flows should be with the pension funds and insurers or the CMBS markets, which would have historically catered for this. Obviously, CMBS markets are still seized and bundling up properties assets has become a busted flush.
